Iowa Sen. Charles Grassley suggested that AIG
executives should accept responsibility for the collapse of the insurance giant
by resigning or killing themselves. The Republican lawmaker's harsh comments
came during an interview Monday with Cedar Rapids, Iowa, radio station WMT . . .
Sen. Charles Grassley wants AIG executives to apologize for the collapse of the
insurance giant — but said Tuesday that "obviously" he didn't really mean that
they should kill themselves. The Iowa Republican raised eyebrows with his
comments Monday that the executives — under fire for passing out big bonuses
even as they were taking a taxpayer bailout — perhaps should "resign or go
commit suicide." But he backtracked Tuesday morning in a conference call with
reporters. He said he would like executives of failed businesses to make a more
formal public apology, as business leaders have done in Japan. Noel Duara, "Grassley: AIG execs
should repent, not kill selves," Yahoo News, March 17, 2009 ---
http://news.yahoo.com/s/ap/20090317/ap_on_re_us/grassley_aig

In late February, Charles Ferguson’s film – Inside
Job – won the Academy Award for Best Documentary. And now the film
documenting the causes of the 2008 global financial meltdown has made its
way online (thanks to the Internet Archive). A corrupt financial industry,
its corrosive relationship with politicians, academics and regulators, and
the trillions of damage done, it all gets documented in this film that runs
a little shy of 2 hours.

To watch the film, you will need to do the
following. 1.) Look at the bottom of the film. 2.) Click the forward button
twice so that it moves beyond the initial trailer and the Academy Awards
ceremony. 3.) Wait for the little circle to stop spinning. And 4.) click
play to watch film.

Inside Job (now listed in our Free Movie
Collection) can be purchased on DVD at Amazon. We all love free, but let’s
remember that good projects cost real money to develop, and they could use
real financial support. So please consider buying a copy.

Hopefully watching or buying this film won’t be a
pointless act, even though it can rightly feel that way. As Charles Ferguson
reminded us during his Oscar acceptance speech, we are three years beyond
the Wall Street crisis and taxpayers (you) got fleeced for billions. But
still not one Wall Street exec is facing criminal charges. Welcome to your
plutocracy…

Appendix C: Don't Blame Fair Value Accounting Standards
(except in terms of executive bonus payments)
This includes a bull crap case based on an article by the former head of the
FDIC

Appendix D: The
End of Capitalism, Economics, and Investment Banking as We Know It

Appendix E: Greatest Swindle
in the History of the WorldYour Money at
Work, Fixing Others’ Mistakes (includes a great NPR public radio audio module)

Appendix F: Christopher Cox Waits Until Now
to Tell Us His Horse Was Lame All Along
S.E.C. Concedes Oversight Flaws Fueled Collapse
And This is the Man Who Wants Accounting Standards to Have Fewer Rules

Peter Schiff
is a widely-known economist who predicted the financial crisis well ahead of
most everybody, but nobody listened when he blared out warnings throughout
the media, some of which are on YouTubeNo, the main issue with Schiff seems to be that he
hasn't changed his tune (in 2009) --- and it
isn't a pleasant tune to listen to. He thinks the "phony economy" of the U.S. is
headed for even harder times. He believes that the crisis-fighting measures
coming out of Washington are merely delaying the inevitable, debasing the dollar
and loading future taxpayers with huge debts.Justin Fox, "Excluding the
Extremist: Peter Schiff predicted the credit collapse long before the
'experts." So why is it so hard to hear him now," Time Magazine, June 1,
2009, Page 48.

Oh, and don't forget Fannie Mae and Freddie Mac,
those two government-sponsored mortgage giants that engineered the 2008 subprime
mortgage fiasco and are now on the public dole. The Fed kept them afloat by
buying over a trillion dollars of their paper. Now, part of the Treasury's
borrowing from the public covers their continuing large losses. George Melloan, "Hard Knocks From Easy
Money: The Federal Reserve is feeding big government and harming
middle-class savers," The Wall Street Journal, July 6, 2010 ---
http://online.wsj.com/article/SB10001424052748704103904575337282033232118.html?mod=djemEditorialPage_t

Senior Harvard University
officials -- especially then-president Lawrence Summers -- repeatedly ignored
warnings that the university's investment strategies were placing far too much
cash (needed for short-term spending) in risky investments,
The Boston Globe reported. The placement of
the cash in risky investments has been a key reason why Harvard, which even
after investment losses is by far the wealthiest university in the world, has
been forced to make many cuts in the last year; such cash reserves, had the
advice been followed, would have been easily accessible. Summers declined to
comment for the article, but a friend of his familiar with the Harvard
investment strategy noted that conditions changed after Summers left the
presidency and that the university had the time to change its strategy prior to
last year's Wall Street collapse.

Jensen Comment
There were advanced warnings before the fall, especially those of Peter Schiff
---
http://en.wikipedia.org/wiki/Peter_Schiff
But he missed the early timing and thus is still not a billionaire.
Larry Summers resigned from Harvard in a clash with feminists and is now the
chief economic advisor to President Obama.

An entire generation's prosperity vanishing, food
stamp use exploding. Welcome to the jobless future. This month's jobs numbers
drive home the point. The unemployment rate fell at the fastest rate for years —
great news, right? Wrong. The vast majority of the gains — 75% — came from (wait
for it) "temporary help services." See what just happened? We subtracted
thousands of real jobs — and replaced them with low-value, no-future McJobs
instead. "Solve America's Employment Crisis With a Netflix Prize," Harvard
Business School, December 4, 2009 ---
http://blogs.harvardbusiness.org/haque/2009/12/solve_americas_employment_cris.html?cm_mmc=npv-_-DAILY_ALERT-_-AWEBER-_-DATE

I have to admit to a profound
dislike for former Harvard President and former Obama (and Clinton)
advisor Larry Summers. Besides the fact that, at least going by a number
of reports of people who have known him, he can only be characterized as
a dick, he represents precisely what is wrong with a particularly
popular mode of thinking in this country and, increasingly, in the rest
of the world.

Lawrence was famously forced to resign as
president of Harvard in 2006 because of a no-confidence vote by the
faculty (wait, academics still have any say in how universities are run?
Who knew) because of a variety of reasons, including his conflict with
academic star Cornel West, financial conflict of interests regarding his
dealings with economist Andrei Shleifer, and particularly his remarks to
the effect that perhaps the scarcity of women in science and engineering
is the result of innate intellectual differences (for a critical
analysis of that particular episode see Cornelia Fine’s
Delusions of Genderand the
corresponding
Rationally Speaking podcast).

Now I have acquired yet another reason to dislike
Summers, while reading Debra Satz’s
Why Some Things Should not Be for Sale:
The Moral Limits of Markets,
which I highly recommend to my libertarian friends, as much as I realize
of course that it will be entirely wasted on them. The book is a
historical and philosophical analysis of ideas about markets, and makes
a very compelling case for why thinking that “the markets will take care
of it” where “it” is pretty much anything of interest to human beings is
downright idiotic (as well as profoundly unethical).

But I’m not concerned here with Satz’s book per
se, as much as with the instance in which she discusses for her
purposes, a memo written by Summers when he was chief economist of the
World Bank (side note to people who still don’t think we are in a
plutocracy: please simply make the effort to track Summers’ career and
his influence as an example, or check
this short video by one of my favorite
philosophers, George Carlin). The memo was intended for internal WB use
only, but it caused a public uproar when the, surely not left-wing,
magazine The Economist leaked it to the public. Here is an
extract from the memo (emphasis mine):

“Just between you and me, shouldn’t
the World Bank be encouraging more migration of the dirty industries to
the less developed countries? I can think of three reasons:

1. The measurement of the costs of
health-impairing pollution depends on the foregone earnings from
increased morbidity and mortality. From this point of view a given
amount of health-impairing pollution should be done in the country with
the lowest cost, which will be the country with the lowest wages. I
think the economic logic behind dumping a load of toxic waste in the
lowest wage country is impeccable and we should face up to that.

2. The costs of pollution are
likely to be non-linear as the initial increments of pollution probably
have very low cost ... Only the lamentable facts that so much pollution
is generated by non-tradable industries (transport, electrical
generation) and that the unit transport costs of solid waste are so high
prevent world-welfare enhancing trade in air pollution and waste.

3. The demand for a clean
environment for aesthetic and health reasons is likely to have very high
income elasticity ... Clearly trade in goods that embody aesthetic
pollution concerns could be welfare enhancing.

The problem with the arguments
against all of these proposals for more pollution in least developed
countries (intrinsic rights to certain goods, social concerns, lack of
adequate markets, etc.) could be turned around and used more or less
effectively against every Bank proposal for liberalization.”

Now, pause for a minute, go back to
the top of the memo, and read it again. I suggest that if you find
nothing disturbing about it, your empathic circuitry needs a major
overhaul or at the very least a serious tuneup. But it’s interesting to
consider why.

As both The Economist (who
called the memo “crass”) and Satz herself note, the economic logic of
the memo is indeed impeccable. If one’s only considerations are economic
in nature, it does make perfect sense for less developed countries to
accept (for a — probably low — price) the waste generated by richer
countries, for which in turn it makes perfect sense to pay a price to
literally get rid of their shit.

And yet, as I mentioned, the leaking of the memo
was accompanied by an outcry similar to the one generated by the equally
infamous “Ford
Pinto memo” back in 1968. Why? Here I
actually have a take that is somewhat different from, though
complementary to, that of Satz. For her, there are three ethical
objections that can be raised to the memo: first, she maintains that
there is unequal vulnerability of the parties involved in the bargain.
That is, the poor countries are in a position of marked disadvantage and
are easy for the rich ones to exploit. Second, the less developed
countries likely suffer from what she calls weak agency, since they tend
to be run by corrupt governments whose actions are not in the interest
of the population at large (whether the latter isn’t also true of
American plutocracy is, of course, a matter worth pondering). Third, the
bargain is likely to result in an unacceptable degree of harm to a
number of individuals (living in the poor countries) who are not going
to simultaneously enjoy any of the profits generated from the
“exchange.”

"The dominant public policy
imperative motivating reform is to address the moral hazard risk created by what
we did, what we had to do in the crisis to save the economy," Treasury Secretary
Timothy F. Geithner said in an interview. That's from today's Washington Post.
The "moral hazard risk" arises when government encourages people to gamble by
suggesting that government will rescue them if they fail. By bailing out the
banks, the federal government has essentially declared to the world that they
will do it again. That created a moral hazard. It's refreshing to know that
Administration is aware of... John Stossel, "Geithner Moral
Hazard," ABC News, August 28, 2009 ---
http://blogs.abcnews.com/johnstossel/2009/08/geithner-moral-hazard.html

Ten (now eleven) Trillion and Counting
(a full-length PBS Frontline video) ---
http://www.pbs.org/wgbh/pages/frontline/tentrillion/view/All of the federal government's efforts to
stem the tide of the financial meltdown have added hundreds of billions of
dollars to an already staggering national debt, a sum that is expected to double
over the next 10 years to more than $23 trillion. In Ten Trillion and Counting,
FRONTLINE traces the politics behind this mounting debt and investigates what
some say is a looming crisis that makes the current financial situation pale in
comparison

This
is a great learning resource: Very Effective
Visual Guide to the Federal Reserve," Simoleon Sense, May 22, 2009 ---
http://www.simoleonsense.com/
Jensen Comment
The Fed's easy credit and low-interest policies of the past two decades got us
into this financial crisis, and the Fed's approach to getting us out of this
mess is like putting gasoline on political fire.

I’d
been working for the bank for about five weeks when I woke up on the balcony of
a ski resort in the Swiss Alps. It was midnight and I was drunk. One of my
fellow management trainees was urinating onto the skylight of the lobby below
us; another was hurling wine glasses into the courtyard. Behind us, someone had
stolen the hotel’s shoe-polishing machine and carried it into the room; there
were a line of drunken bankers waiting to use it. Half of them were dripping
wet, having gone swimming in all their clothes and been too drunk to remember to
take them off. It took several more weeks of this before the bank considered us
properly trained. . . . By the time I arrived on Wall Street in 1999, the link
between derivatives and the real world had broken down. Instead of being used to
reduce risk, 95 per cent of their use was speculation - a polite term for
gambling. And leveraging - which means taking a large amount of risk for a small
amount of money. So while derivatives, and the financial industry more broadly,
had started out serving industry, by the late 1990s the situation had reversed.
The Market had become a near-religious force in our culture; industry, society,
and politicians all bowed down to it. It was pretty clear what The Market didn’t
like. It didn’t like being closely watched. It didn’t like rules that governed
its behaviour. It didn’t like goods produced in First-World countries or workers
who made high wages, with the notable exception of financial sector employees.
This last point bothered me especially. Philipp Meyer,
American Rust (Simon & Schuster, 2009) ---
http://search.barnesandnoble.com/American-Rust/Philipp-Meyer/e/9780385527514/?itm=1
American excess: A Wall Street trader tells all - Americas, World - The
Independent
http://www.independent.co.uk/news/world/americas/american-excess--a-wall-street-trader-tells-all-1674614.html
Jensen Comment
This book reads pretty much like an update on the derivatives scandals featured
by Frank Partnoy covering the Roaring 1990s before the dot.com scandals broke.
There were of course other insiders writing about these scandals as well ---
http://www.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
It would seem that bankers and investment bankers do not learn from their own
mistake. The main cause of the scandals is always pay for performance schemes
run amuck.

A growing concern for Fed policy
makers is a weakening in the US dollar against major currencies. The price of
the euro in US-dollar terms climbed from a low of $1.27 in November last year to
around $1.41 in May and $1.43 in early June — an increase of 12.6% from
November. The major currencies dollar index fell to 78.89 in May from 82.3 in
April — a fall of 4.1%. If the declining trend in the US dollar were to
consolidate, this could cause foreign holders of US-dollar assets to divest into
non-dollar-denominated assets and precious metals.Frank Shostak, "The Fed Might Have
Painted Itself into a Corner," Mises Institute, June 12, 2009 ---
http://mises.org/story/3518

Let me conclude with a political note. The main reason for
reform is to serve the nation. If we don’t get major financial reform now, we’re
laying the foundations for the next crisis. But there are also political reasons
to act. For there’s a populist rage building in this country, and President
Obama’s kid-gloves treatment of the bankers has put Democrats on the wrong side
of this rage. If Congressional Democrats don’t take a tough line with the banks
in the months ahead, they will pay a big price in November. Paul Krugman, Bubbles and
the Banks," The New York Times, January 7, 2010 ---
http://www.nytimes.com/2010/01/08/opinion/08krugman.html?hpw

SUMMARY: "Bank of America Corp. agreed to pay $2.43 billion to
settle claims it misled investors about the acquisition of troubled
brokerage firm Merrill Lynch & Co...." during the financial crisis in 2008.
At the time it acquired Merrill Lynch in September 2008, BofA became the
biggest U.S. bank; the value of the bank then fell by more than half by the
time the acquisition of Merrill Lynch closed 3 months later. These losses
were not disclosed by then CEO Ken Lewis and his management team to
shareholders before they voted on the merger transaction with Merrill.

CLASSROOM APPLICATION: The article addresses accounting for
litigation contingent liabilities. The related video clearly discusses the
history of the transactions.

2. (Introductory) For what losses did BofA agree to make this
payment?

3. (Advanced) How could losses have occurred and a payment of $2.4
billion be required if "Bank of America executives now say Merrill...has
become a big profit contributor... [and that] it's clear that Merrill is a
significant positive any way you want to look at it..."?

4. (Advanced) What accounting standards provide the requirements to
account for costs such as this $2.4 billion payment by BofA?

5. (Advanced) According to the article, BofA has "set aside more
than $42 billion in litigation expenses, payouts and reserves...[which]
includes $1.6 billion taken in the third quarter [of 2012]...." According to
the related video, what period will be affected by $1.6 billion being
recorded as an expense related to this $2.43 billion settlement? Explain
your answer.

Bank of America Corp. agreed to pay $2.43 billion
to settle claims it misled investors about the acquisition of troubled
brokerage firm Merrill Lynch & Co., in the latest financial-crisis
aftershock to rattle the banking sector.

The payment is the largest settlement of a
shareholder claim by a financial-services firm since the upheaval of 2008
and 2009. It also ranks as the eighth-largest securities class-action
settlement, behind payouts like the $7.2 billion settlement with
shareholders of Enron Corp. and the $6.1 billion pact with WorldCom Inc.
investors, both in 2005.

The deal is a sign that U.S. banks' battle to
contain the high cost of the crisis continues to escalate, despite a
four-year slog of lawsuits, losses and profit-sapping regulations. Bank of
America's total exposure to crisis-era litigation is "seemingly
never-ending," said Sterne Agee & Leach Inc. in a note Friday.

Is the era that produced all of this legal exposure
"history?" the Sterne Agee & Leach analysts said. "Unlikely."

The settlement ends a three-year fight with a group
of five plaintiffs, including the State Teachers Retirement System of Ohio
and the Teacher Retirement System of Texas. They accused the bank and its
officers of making false or misleading statements about the health of Bank
of America and Merrill Lynch and were planning to seek $20 billion if the
case went to trial as scheduled on Oct. 22.The size of the pact highlights
how hasty acquisitions engineered during the height of the financial crisis
by Kenneth Lewis, then the bank's chief executive, are still haunting the
company four years later. Decisions to buy mortgage lender Countrywide
Financial Corp. and Merrill have forced Bank of America, run since 2010 by
Chief Executive Brian Moynihan, to set aside more than $42 billion in
litigation expenses, payouts and reserves, according to company figures. The
funds are meant to absorb a litany of Merrill-related lawsuits and claims
from investors who say Countrywide wasn't honest about the quality of
mortgage-backed securities it issued before the crisis.

That total includes $1.6 billion taken in the third
quarter to help pay for the Merrill settlement announced Friday and a
landmark $8.5 billion agreement reached last year with a group of
high-profile mortgage-bond investors.

The company's shares lost more than half their
value between when Bank of America announced its late-2008 plan to purchase
Merrill Lynch and the date the deal closed 3½ months later, wiping out $70
billion in shareholder value. The shares have fallen further since then, and
investors who owned the shares won't be made whole by the settlement.

"We find it simply amazing the sheer magnitude of
value destruction over the years," said Sterne Agee in the note issued
Friday. And "the bill is surely set to increase" as the research firm
expects the bank to reach other legal settlements over the next 12 to 24
months. Bank of America is still engaged in a legal clash with bond insurer
MBIA Inc., MBI+3.91%
which has alleged that Countrywide wasn't honest about the quality of
mortgage-backed securities it issued before the financial crisis.

The move to buy Merrill over one weekend in
September 2008 was initially hailed as a rare piece of good news during a
week when much of Wall Street appeared to be teetering on the brink. It also
vaulted the Charlotte, N.C., lender to the top of the U.S. banking heap,
capping a goal pursued over two decades by Mr. Lewis and his predecessor,
Hugh McColl.

The Merrill deal, initially valued at $50 billion
in Bank of America stock, was the "deal of a lifetime," Mr. Lewis said on
the day it was announced.

But the agreement soon became a problem as analysts
questioned whether Mr. Lewis paid too much and Merrill's losses spiraled out
of control in the weeks before the deal closed. Investor fears stemming from
the financial crisis sent shares of Bank of America and other financial
companies into free fall, and the deal was worth roughly $19 billion at its
completion on Jan. 1, 2009.

Mr. Lewis and his top executives made the decision
not to say anything publicly about the mounting problems before shareholders
signed off on the merger—a decision that formed the basis of a number of
Merrill-related suits, including an action brought by the Securities and
Exchange Commission. The bank also didn't disclose that it sought $20
billion in U.S. aid to digest Merrill, or that the deal allowed Merrill to
award up to $5.8 billion in performance bonuses. When Bank of America
threatened to pull out of the deal because of the losses, then-Treasury
Secretary Henry Paulson told Mr. Lewis that current management would be
removed if the deal wasn't completed.

The legal scrutiny surrounding the Merrill
acquisition contributed to Mr. Lewis's decision to step down at the end of
2009. Mr. Lewis's lawyer declined to comment.

"Any way you slice it, $2.4 billion is a big
number," says Kevin LaCroix, a lawyer at RT ProExec, a firm that focuses on
management-liability issues.

Bank of America executives now say Merrill, unlike
Countrywide, has become a big profit contributor, while the company
continues to work to absorb massive losses in its mortgage division. The
divisions inherited from Merrill produced $31.9 billion in net income
between 2009 and 2011 and $164.4 billion in revenue. Bank of America's total
net income over the period was just $5.5 billion, on $326.8 billion in
revenue, reflecting in part the hefty losses tied to the Countrywide deal.

"I think it's clear that Merrill is a significant
positive any way you want to look at it," said spokesman Jerry Dubrowski.

The settlement doesn't end all Merrill-related
headaches. The New York attorney general's office still is pursuing a
separate civil fraud suit relating to the Merrill takeover that began under
former Attorney General Andrew Cuomo. Defendants in that case include the
bank, Mr. Lewis and former Chief Financial Officer Joe Price. A spokesman
for New York State Attorney General Eric Schneiderman declined to comment.

It isn't known how much all shareholders will
receive as a result of the Merrill settlement announced Friday. The amount
shareholders receive will ultimately depend on how long they held the shares
and how much they paid. Mr. Lewis, also a shareholder, won't receive a
payout because defendants in the suit are excluded from the class that the
court certified.

But because the decline in Bank of America stock
was so steep—the shares fell from $32 to $14 between Sept. 12, 2008, the day
before the Merrill acquisition was announced, and the Jan. 1, 2009,
closing—no shareholders can expect to recover their full losses.

Before the settlement was reached, a targeted
recovery for at least three million shareholders who were part of the class
was $2.52 a share, said a spokesman for Ohio Attorney General Mike DeWine.
The State Teachers Retirement System of Ohio and the Ohio Public Employees
Retirement System, which held between 18 million and 20 million shares, now
expect to recover $1.19 per share, or roughly $20 million.

Jensen Comment
Arguably the worst decision in the 2008 economic bailout was Bank of America's
decision to buy the bankrupt Countrywide Financial. BofA then CEO Lewis claims
to this day that Treasury Secretary Hank Paulsen held a gun to his head and said
buy Countrywide Financial or else. Countrywide has been nothing but a cash flow
hemorrhage for BofA ever since.

Breaking the Bank Frontline
VideoIn Breaking the Bank, FRONTLINE producer Michael Kirk
(Inside the Meltdown, Bush’s War) draws on a rare combination of high-profile
interviews with key players Ken Lewis and former Merrill Lynch CEO John Thain to
reveal the story of two banks at the heart of the financial crisis, the rocky
merger, and the government’s new role in taking over — some call it
“nationalizing” — the American banking system. Simoleon Sense, September 18,
2009 ---
http://www.simoleonsense.com/video-frontline-breaking-the-bank/
Bob Jensen's threads on the banking bailout ---
http://www.trinity.edu/rjensen/2008Bailout.htm

U.S. loan relief program
may have made things worseThe Obama administration’s $75 billion program to
protect homeowners from foreclosure has been widely pronounced a disappointment,
and some economists and real estate experts now contend it has done more harm
than good. Since President Obama announced the program in February, it has
lowered mortgage payments on a trial basis for hundreds of thousands of people
but has largely failed to provide permanent relief. Critics increasingly argue
that the program, Making Home Affordable, has raised false hopes among people
who simply cannot afford their homes.
Peter S. Goodman, "U.S. loan program may have made things worse," MSNBC,
January 1, 2010 ---
http://www.msnbc.msn.com/id/34663078/ns/business-the_new_york_times/

Selling the debt in the left pocket to the right pocket: The Fed is
all smoke and mirrors

In his attempt to explode the myth that there is
unlimited demand for U.S. government debt, former Treasury official Lawrence
Goodman explained that there
is high perceived demand because the Federal Reserve is doing most
of the buying.

Wrote Goodman,

Last year the Fed
purchased a stunning 61% of the total net Treasury issuance, up from
negligible amounts prior to the 2008 financial crisis.

This not only creates
the false impression of limitless demand for U.S. debt but also blunts any
sense of urgency to reduce supersized budget deficits.

What about Japan and China? Aren’t they the major
purchasers of U.S. debt? Not any more, notes Goodman. Foreign purchases of
U.S. debt dropped to less than 2 percent of GDP (Gross Domestic Product)
from almost 6 percent just three years ago. And private sector investors —
banks, money market and bond mutual funds, individuals and corporations —
have cut their buying way back as well, to less than 1 percent of GDP, down
from 6 percent. This serves to hide the fact that the government can’t find
outside buyers willing to accept rates of return that are below the
inflation rate (“negative interest”) given the precarious financial
condition of the government. It also hides the impact of $1.3 trillion
deficits from the public who would likely get much more concerned if real,
true market rates of interest were being demanded for purchasing U.S. debt,
as such higher rates would increase the deficit even further. Finally it
takes pressure off Congress to “do something” because there is no public
clamor over the matter, at least for the moment.

One of those promoting the myth that buyers of U.S.
debt must exist because interest rates are so low is none other than one of
those recently seated at the Federal Reserve’s Open Market Committee table,Alan
Blinder. Now a professor of economics at Princeton
University, Blinder was vice chairman of the Fed in the mid-nineties and
should know all about the Fed’s manipulations and machinations in the money
markets. Apparently not.

Strange as it may seem
with trillion-dollar-plus deficits, the U.S. government doesn’t have a
short-run borrowing problem at all. On the contrary, investors all over the
world are clamoring to lend us money at negative real interest rates.

In purchasing power
terms, they are paying the U.S. government to borrow their money!

Blinder
repeated the errorin front of the Senate Banking
Committee just one week later: "In fact, world financial markets are eager
to lend the United States government vast amounts at negative real interest
rates. That means that, in purchasing power terms, they are paying us to
borrow their money!"

Aggressive promotion of a myth never makes it a
fact. All it does is hide, for a period, the reality that the world isn’t
willing to lend to the United States at negative interest rates. This places
the burden on the Fed to make the myth appear real by expanding its own
balance sheet and gobbling up U.S. debt.

There are going to be consequences. As Goodman put
it,

The failure by officials
to normalize conditions in the U.S. Treasury market and curtail ballooning
deficits puts the U.S. economy and markets at risk for a sharp
correction…. [Emphasis added.]

In other words, budget
deficits often take years to build or reduce, while financial markets react
rapidly and often unexpectedly to deficit spending and debt.

Therecent
release by the Congressional Budget Office (CBO)
of future inflation expectations provides little assurance either as it
mimics the line that inflation will stay low for the foreseeable future: "In
CBO’s forecast, the price index for personal consumption expenditures
increases by just 1.2 percent in 2012 and 1.3 percent in 2013."

With the Fed continuing to buy U.S. government
debt, which keeps interest rates artificially low, when will reality set in?
Amity Shlaes has the answer.
Writing in Bloomberg last week, Shlaes explains:

The thing about [price]
inflation is that it comes out of nowhere and hits you….

[It] has happened to us
before. In World War I … the CPI [Consumer Price Index] went from 1 percent
for 1915 to 7 percent in 1916 and 17 percent in 1917….

In 1945, all seemed
well. Inflation was at 2 percent, at least officially. Within two years that
level hit 14 percent.

All appeared calm in
1972, too, before inflation jumped to 11 percent by 1974 and stayed high for
the rest of the decade….

One thing is clear:
pretty soon, we’ll all be in deep water.

Doug Casey agrees: “Don’t think there are no
consequences to our unwise fiscal and monetary course; a potentially ugly
tipping point is more likely than not at some point.”

I don't want to make this statement of fact seem political.
It applies no matter what political side is in power!
The Science of Macroeconomics is quite literally blameless.

If the economy improves and unemployment drops,
Obama can take credit. If it fails to improve and unemployment rises, though, he
can say he averted an even worse showing. Republicans will take the opposite
tack—attributing any improvement to the natural resilience of the economy and
blaming the administration if things get worse. And neither side will really
know who's right. I have long been a believer in the value of economics in
understanding the world. But the chief effect of the current crisis is to raise
the possibility that economists—at least those macroeconomists, who study the
broad economy—don't have a blessed clue. "Baffled by the Economy: Why being a macroeconomist means
never having to say you're sorry," by Steve Chapman, Reason Magazine,
June 11, 2009 ---
http://www.reason.com/news/show/134059.html

The budget should be balanced, the Treasury
should be refilled, public debt should be reduced, the arrogance of officialdom
should be tempered and controlled, and the assistance to foreign lands should be
curtailed lest Rome become bankrupt. People must again learn to work, instead of
living on public assistance.Taylor Caldwell, A Pillar of Iron
(wrongly attributed to
Cicero in 55 B.C.)

"For five years, Li's formula, known as a
Gaussian copula function, looked like an unambiguously positive
breakthrough, a piece of financial technology that allowed hugely
complex risks to be modeled with more ease and accuracy than ever
before. With his brilliant spark of mathematical legerdemain, Li made it
possible for traders to sell vast quantities of new securities,
expanding financial markets to unimaginable levels.

His method was adopted by everybody from bond
investors and Wall Street banks to ratings agencies and regulators. And
it became so deeply entrenched—and was making people so much money—that
warnings about its limitations were largely ignored.

Then the model fell apart." The article goes on to show that correlations
are at the heart of the problem.

"The reason that ratings agencies and investors
felt so safe with the triple-A tranches was that they believed there was
no way hundreds of homeowners would all default on their loans at the
same time. One person might lose his job, another might fall ill. But
those are individual calamities that don't affect the mortgage pool much
as a whole: Everybody else is still making their payments on time.

But not all calamities are individual, and
tranching still hadn't solved all the problems of mortgage-pool risk.
Some things, like falling house prices, affect a large number of people
at once. If home values in your neighborhood decline and you lose some
of your equity, there's a good chance your neighbors will lose theirs as
well. If, as a result, you default on your mortgage, there's a higher
probability they will default, too. That's called correlation—the degree
to which one variable moves in line with another—and measuring it is an
important part of determining how risky mortgage bonds are."

I would highly recommend reading the entire thing that gets much more
involved with the
actual formula etc.

The
“math error” might truly be have been an error or it might have simply been a
gamble with what was perceived as miniscule odds of total market failure.
Something similar happened in the case of the trillion-dollar disastrous 1993
collapse of Long Term Capital Management formed by Nobel Prize winning
economists and their doctoral students who took similar gambles that ignored the
“miniscule odds” of world market collapse -- -
http://www.trinity.edu/rjensen/FraudRotten.htm#LTCM

The rhetorical question is whether the failure is ignorance in model building or
risk taking using the model?

Wall Street’s Math Wizards Forgot a Few VariablesWhat wasn’t recognized was the importance of a
different species of risk — liquidity risk,” Stephen Figlewski, a professor of
finance at the Leonard N. Stern School of Business at New York University, told
The Times. “When trust in counterparties is lost, and markets freeze up so there
are no prices,” he said, it “really showed how different the real world was from
our models.
DealBook, The New York Times, September 14, 2009 ---
http://dealbook.blogs.nytimes.com/2009/09/14/wall-streets-math-wizards-forgot-a-few-variables/

Edmunds.com reports that its
statistical analysisof the Cash for Clunkers
program finds that the program generated only 125,000 extra new vehicle
sales, meaning that the cost to the U.S. government was $24,000 for each of
those new cars.

The reason the cost per incremental car is so high
is that, according to Edmunds.com’s modeling, 82 percent of the vehicles
purchased under the program would have been bought this year anyway, even
without the subsidy. So Cash for Clunkers mostly just turned out to be a
gift from the government to people who happened to be in the market for a
new car at the right time. The auto manufacturers and dealers did not end up
getting a very big chunk of the money ultimately, although they did get paid
earlier rather than later in the year.

Is this surprising? Not to an economist. It is
relatively easy to move around the timing of when someone purchases a
durable good, but much harder to affect whether they buy a durable good or
not.

For the second time in a week, I am deeply
disappointed at the response of the Department of Transportation to research
into areas of relevance to the department. The first case was Secretary
LaHood’s response to my research on car seats. Here is what the agency had
to say in response to the Edmunds.com analysis:

“It is unfortunate that Edmunds.com has had
nothing but negative things to say about a wildly successful program
that sold nearly 250,000 cars in its first four days alone,” said Bill
Adams, spokesman for the Department of Transportation.

The right response, it seems to me, is either to
say 1) that this new evidence convinces us not to do the program again, or
2) that this analysis is wrong. That’s
the response that Macon Phillips had on the
White House blog (who knew the White House had a blog!):

The Edmunds analysis rests on the assumption
that the market for cars that didn’t qualify for Cash for Clunkers was
completely unaffected by this program. In other words, all the other
cars were being sold on Mars, while the rest of the country was caught
up in the excitement of the Cash for Clunkers program. This analysis
ignores not only the price impacts that a program like Cash for Clunkers
has on the rest of the vehicle market, but the reports from across the
country that people were drawn into dealerships by the Cash for Clunkers
program and ended up buying cars even though their old car was not
eligible for the program.

I’m not sure whether this argument is empirically
important or not, but at least it is actually engaging in a meaningful way
with the Edmunds.com analysis.

Jensen Comment
My objection to the Cash for Clunkers Program was not how much it cost in terms
of subsidies to some buyers (like me) and most dealers, although the benefits to
buyers are probably overstated when compared to deals that are not being made by
dealers. My objection is that the program destroyed perfectly good cars needed
badly by poor people around the world such as poor people in Latin America and
South America. Mathematicians would call the degree of impact epsilon with
respect to reducing global warming and fuel consumption.
The
so-called "jobs created" were mostly temporary since backlogged vehicle
inventories are now growing and growing and growing.

A very small example was the cash for clunkers
program in the US that ended a short time ago. The 19th century French essayist
Frederic Bastiat discussed facetiously the gain to an economy when a boy breaks
the windows of a shopkeeper since that creates work for the glazier to repair
them, and the glazier then spends his additional income on food and other
consumer goods. The moral of that story is to hire boys to go around breaking
windows! The clunkers program was hardly any better than that (see our
discussion of the clunkers program on August 24th).Gary Becker, Nobel Prize Winning
Economist, "How Much Should We Care About Government Deficits?" The
Becker-Posner Blog, September 15, 2009 ---
http://www.becker-posner-blog.com/archives/2009/09/how_much_should.html
Also see Gary Becker, "The Cash for Clunkers Program: A Bad Idea at the
Wrong Time, The Becker-Posner Blog, August 24, 2009 ---
http://www.becker-posner-blog.com/archives/2009/08/the_cash_for_cl.html

The burden on the government budget that this
imposes depends on the interest rates on the debt. At an average interest rate
of 5%, that means 5% of GDP would go to servicing the debt, which is a little
less than 20% of total federal government spending. This might be manageable but
it is not trivial. On the other hand, if average interest rates were only 3%,
servicing costs would be far more tolerable. In fact, the US has been paying
about 3% on its debt, so even a considerable increase of the debt to 100% of GDP
would still be manageable. But if the Fed starts raising real interest rates to
head off the inflation potential in the $800 billion of excess reserves, the
debt burden could become a major problem. Another factor is the savings rates
coming from the Asian countries, like China. If their savings decline sharply,
that too would raise world interest rates and increase the debt burden for all
countries.Gary Becker, Nobel Prize Winning
Economist, "How Much Should We Care About Government Deficits?" The
Becker-Posner Blog, September 15, 2009 ---
http://www.becker-posner-blog.com/archives/2009/09/how_much_should.html

Mortgage Fraud IncreasingDespite the attention paid to mortgage fraud committed
by borrowers and lenders since declines in the real estate values and the
subprime loan crisis triggered severe problems in the banking industry, the
number of Federal Bureau of Investigation’s (FBI) investigations of mortgage
fraud and associated financial crimes is increasing. “The FBI has experienced
and continues to experience an exponential rise in mortgage fraud
investigations,” John Pistole, Deputy Director, told the Senate Judiciary
Committee in April. AccountingWeb, August 18, 2009 ---
http://www.accountingweb.com/topic/mortgage-loan-fraud-increasing
Jensen Comment
I think mortgage fraud will continue to rise as long as remote third parties
like Fannie Mae, Freddie Mac, and FHA continue to buy up mortgages negotiated by
banks and mortgage companies basking in moral hazard. The biggest hazards are
fraudulent real estate appraisals and lies about income in mortgage
applications. We need to bring back George Bailey (James Stewart) in It's a
Wonderful Life ---
http://en.wikipedia.org/wiki/It%27s_a_Wonderful_Life
The banks that negotiate the mortgages should have to hang on to those
mortgages.Watch the video at
http://www.youtube.com/watch?v=MJJN9qwhkkE

Critics of Fannie Mae and Freddie Mac were waved
off as cranks and assured that the companies wouldn't need a taxpayer
bailout right up until the moment that they did. Some $112 billion later and
counting, this political history may be repeating itself with the Federal
Housing Administration, which yesterday announced that its capital reserve
ratio has fallen to 0.53%.

That cushion is far below the 2% of its liabilities
that Congress mandates, itself a 50 to 1 leverage ratio, and down from 3%
last autumn. The FHA's mortgage guarantees in 2009 are four times higher
than they were in 2007. Nearly 18% of its loans are 30 days or more past
due, while mortgages guaranteed in 2007 are "on par with FHA's worst-ever
books from the early 1980s," according to the Department of Housing and
Urban Development's report to Congress. The financial deterioration is the
result of the agency's plunge into high-risk loans over the last two years,
asking dangerously low down payments of 3.5% from unqualified borrowers.

The FHA strikes a note of optimism by claiming that
its book of business is improving and that "the just-completed actuarial
studies show that FHA's capital reserve ratio will not dip below zero under
most of the economic scenarios considered." The Administration has also made
some modest reforms. Still, if housing values don't recover, or if by some
chance the agency can't outrun its problems, the report admits that the FHA
could ask taxpayers for $1.6 billion in 2012. Judging from history, that's
probably a low-ball estimate.

Congress doesn't mind because these liabilities are
technically off budget, until they aren't. This was all so predictable—and,
ahem, predicted.

Abstract:
The economics profession appears to have been unaware of the long build-up
to the current worldwide financial crisis and to have significantly
underestimated its dimensions once it started to unfold. In our view, this
lack of understanding is due to a misallocation of research efforts in
economics. We trace the deeper roots of this failure to the profession’s
insistence on constructing models that, by design, disregard the key
elements driving outcomes in real-world markets. The economics profession
has failed in communicating the limitations, weaknesses, and even dangers of
its preferred models to the public. This state of affairs makes clear the
need for a major reorientation of focus in the research economists
undertake, as well as for the establishment of an ethical code that would
ask economists to understand and communicate the limitations and potential
misuses of their models.

Two Videos Damning Capitalism: One Stupid, One Smart

Michael Moore cheered the bankruptcy of General Motors and absolutely
despises the comeback of General Motors
He has a relatively long list (some lucrative to him) leftist documentaries ---
http://en.wikipedia.org/wiki/Michael_Moore
His documentary Sicko got it wrong --- Cuba is not the dream country of
equity and quality in health care for the masses
Now he has a new documentary entitled: Capitalism: A Love Story

"The wealthy, at some
point, decided they didn't have enough wealth. They wanted more -- a lot more.
So they systematically set about to fleece the American people out of their
hard-earned money."

How ridiculous is that?
The wealthy, and everyone else, almost always decide that they don’t have enough
wealth. People ask their bosses for raises. We invest in stocks hoping for
bigger returns than Treasury Bonds bring. “Greed” is a constant. The beauty of
free markets, when government doesn’t meddle in them, is that they turn this
greed into a phenomenal force for good. The way to win big money is to serve
your customers well. Profit-seeking entrepreneurs have given us better
products, shorter work days, extended lives, and more opportunities to write the
script of our own life.

On Thursday, Moore
announcedthe title of the movie:
Capitalism: A Love Story.

It’s a title I might have
picked to make a point opposite of what I assume Moore has in mind.

Moore ought to understand
that, because he makes a good point when he says his movie will be about "the
biggest robbery in the history of this country - the massive transfer of U.S.
taxpayer money to private financial institutions."

Being Honest About Being Dishonest
Democrats openly admit that most of the stimulus money is going to counties that
voted for ObamaA new study released by USA Today also finds that
counties that voted for Obama received about twice as much stimulus money per
capita as those that voted for McCain. "The stimulus bill is designed to help
those who have been hurt by the economic downturn.... Do you see disparity out
there in where the money is going? Certainly," a Democratic congressional
staffer knowledgeable about the process told FOXNews.com. John Lott, "ANALYSIS: States Hit
Hardest by Recession Get Least Stimulus Money," Fox News, July 19,
2009---
http://www.foxnews.com/story/0,2933,533841,00.html

Their report,
"Dreaming with BRICs: The Path to 2050," predicted that within 40
years, the economies of Brazil, Russia, India and China - the BRICs
- would be larger than the US, Germany, Japan, Britain, France and
Italy combined. China would overtake the US as the world's largest
economy and India would be third, outpacing all other industrialised
nations.
"Out of the shadows," Sydney Morning Herald, February 5, 2005
---
http://www.smh.com.au/text/articles/2005/02/04/1107476799248.html

The first economist, an early
Nobel Prize Winning economist, to raise the alarm of entitlements in
my head was Milton Friedman. He has written extensively about the
lurking dangers of entitlements. I highly recommend his fantastic
"Free to Choose" series of PBS videos where his "Welfare of
Entitlements" warning becomes his principle concern for the future
of the Untied States 25 years ago ---
http://www.ideachannel.com/FreeToChoose.htm

Our legislators did
not heed his early warnings, and now we are no longer "free to
choose."

Disclaimer
I've never been a fan of the progressive scholarship of Alan Blinder. He's been
a promoter of low (virtually zero) interest rates for megabanks that I think are
turning into a disaster in this economic recovery. Ben Bernanke can do no wrong
in the eyes of Professor Blinder. In my opinion, the real Bernanke-Blinder
disaster is their support of restraining the government budget deficit with
Zimbabwe economics that entails printing more greenbacks (over $2 trillion to
date) rather than taxing or borrowing what is needed to fight the deficit.
Actually the government does not add to the money supply by literally printing
greenbacks. But having the Fed buy up over 60% of the new government debt is
tantamount to printing greenbacks.

Taxing and borrowing to support government spending are going out of
style.
The main problem with Zimbabwe economics is that it does little to restrain the
excesses of government spending --- which we are now witnessing in the economic
mess in Greece. Greece, of course, cannot simply print Euros to continue to feed
government spending excesses. Greece has to get out of the Euro Zone to engage
in the Zimbabwe economics of Benanke and Blinder. Of course all of Europe might
soon engage in Zimbabwe economics to pay its debts. Taxing and borrowing to
support government spending are going out of style.

The budget should be balanced, the Treasury
should be refilled, public debt should be reduced, the arrogance of officialdom
should be tempered and controlled, and the assistance to foreign lands should be
curtailed lest Rome become bankrupt. People must again learn to work, instead of
living on public assistance.Taylor Caldwell, A Pillar of Iron
(wrongly attributed to Cicero in 55 B.C.)

But under my philosophy of sharing all sides of arguments, I forward the
following case.
Teaching Case from The Wall Street Journal Accounting Weekly Review on
May 25, 2012

SUMMARY: Alan S. Blinder "...is a former vice chairman of the
Federal Reserve [and is now] a professor of economics and public affairs at
Princeton University." This opinion page piece provides a clear explanation
of macroeconomic effects of budget deficits, tax cuts, and spending cuts,
emphasizing the "macroeconomic effects of budget deficits in the short and
long runs."

CLASSROOM APPLICATION: The article is useful in either a tax course
or a governmental accounting class. The related article presents letters to
the editor with more Republican viewpoints than Mr. Blinder's.

QUESTIONS:
1. (Advanced) What are budget deficits?

2. (Introductory) Why can budget deficit spending be beneficial for
the U.S. economy in the short run?

3. (Introductory) Why are budget deficits bad for the U.S. economy
in the long run?

4. (Advanced) What tax law changes are imminent in January 2013?
How do they relate to the comic graphic associated with this opinion piece?
In your answer, comment on the size of these changes relative to the total
economy.

5. (Introductory) How might specific choices in spending be more
helpful than other possible choices? In your answer, explain the use of
return on investment in these decisions, defining that finance concept as
well.

6. (Introductory) What is the biggest cost component that could
most readily reduce the long term budget deficit problem we face in the
U.S.?

7. (Introductory) What does Mr. Blinder recommend as a plan for our
national fiscal policy?

Can we talk about the federal budget deficit?
Better yet, can we think about it? For there has been a lot more talking
than thinking. One persistent point of confusion arises from the radically
different macroeconomic effects of larger budget deficits in the short and
long runs.

In the short run—let's say within a year or so—a
larger deficit, whether achieved by spending more or taxing less, boosts
economic growth by increasing aggregate demand. It's pretty simple. If the
government spends more money without raising anyone's taxes to pay the
bills, that adds to total demand directly.

That's true, by the way, whether you like the
specific expenditures or hate them. Similarly, cutting somebody's taxes
without also cutting spending raises spending indirectly—again, whether you
like the tax cut or not.

A second layer of subtlety recognizes that some
types of spending and some types of tax cuts have larger effects on spending
than others, and similarly, that some types are more sharply targeted on job
creation than others. Such details matter in designing a cost-effective
stimulus package. But for present purposes, let's keep it simple: Higher
spending or lower taxes speed up growth by adding to demand.

So, as long as the government can borrow on
reasonable terms, the crucial short-run question is: Does the economy need
more or less demand? For the last several years, the answer has been clear:
more. Bolstering demand was the rationale for fiscal stimulus under
President Bush in 2008 and under President Obama in 2009. It remains a
persuasive rationale for further stimulus today.

But that's not going to happen. Instead, the
operational budget objective for the coming months is to ensure that we
don't shoot ourselves in the collective foot with fiscal austerity while the
economy is still weak. Sounds foolish, but we could make that grievous error
either by letting ourselves fall off the so-called fiscal cliff that awaits
us in January (tax increases and spending cuts amounting to 3.5%-4% of GDP),
or by crashing headlong into the national debt ceiling, as we almost did
last summer.

But don't we need to reduce the deficit—and by
large amounts? Yes, we do, but that's in the long run, where the effects of
larger deficits are mostly harmful to economic growth. In the jargon, more
government borrowing tends to "crowd out" private borrowers by pushing
interest rates up. Those crowded-out borrowers include both consumers who
want to buy cars and businesses that want to buy equipment. In the latter
case, higher government budget deficits take a toll on growth by slowing
down capital formation.

There is an important exception, however, which is
highly germane to today's situation. Suppose government borrowing is used to
finance productive investments in public capital—such as highways, bridges,
and tunnels. Right now, the U.S. government can borrow for 10 years at under
2% per annum. At these super-low interest rates, you don't have to be a
genius to find many public infrastructure projects with strongly positive
net present values. Borrowing to make such investments will enhance long-run
growth, not retard it. And I can't, for the life of me, understand why we
are not doing more of it.

But other types of spending, and any tax cut that
does not boost capital formation enough, will slow down growth. And that's
the fundamental indictment of large deficits.

To think clearly about how to shrink the long-run
deficit, we must understand its origins. Looking ahead, the lion's share of
projected future deficits comes from rising health-care expenditures.

Some of this cost escalation stems from heavier
usage—consuming more health services per capita. But most of it comes from
ever-rising relative prices; health care just keeps getting more expensive
relative to almost everything else. The good news is that, if we could
somehow limit health-care inflation to the overall inflation rate, much of
the long-run budget problem would virtually vanish. The bad news is that
nobody knows how to do that.

Given this ignorance, President Obama's health-care
reform law, which Republicans want to repeal and the Supreme Court may
vacate, takes a sensible approach to cost control. It includes—either on an
experimental, small-scale, or pilot basis—virtually every cost-containment
idea that has been suggested. The pragmatic attitude is: Let's try
everything and go with what works.

But what about the middle, between the short run
and the long run? When should the federal
government get serious about paring its deficit? There is no formulaic
answer, but U.S. Treasury borrowing rates will provide a clue. When they
start rising on a sustained basis, it will be time to push deficits down.
Another important clue will be the health of the economy.
The government should stop supporting aggregate demand when the
economy is strong enough to stand on its own two feet.

Continued in article

Jensen Comment
What Blinder does not admit to is that government borrowing rates are not
allowed to go up as long as the Fed buys over 60% of the new debt issues in its
Zimbabwe economic policy. I think I'm going to throw up!

Bernanke's money printing press
On March 18, the Federal Reserve announced it would purchase up to $300 billion
of long-term bonds as well as $750 billion of mortgage-backed securities. Of all
the Fed's moves, this "quantitative easing" gets money into the economy the
fastest -- basically by cranking the handle of the printing press and flooding
the market with dollars (in reality, with additional bank credit). Since these
dollars are not going into home building, coal-fired electric plants or auto
factories, they end up in the stock market. A rising market means that banks are
able to raise much-needed equity from private money funds instead of from the
feds. And last Thursday, accompanying this flood of new money, came the
reassuring results of the bank stress tests. The next day Morgan Stanley raised
$4 billion by selling stock at $24 in an oversubscribed deal. Wells Fargo also
raised $8.6 billion that day by selling stock at $22 a share, up from $8 two
months ago. And Bank of America registered 1.25 billion shares to sell this
week. Citi is next. It's almost as if someone engineered a stock-market rally to
entice private investors to fund the banks rather than taxpayers. Andy Kessler, "Was It a Sucker's
Rally? You can have a jobless recovery but you can't have a profitless one,"
The Wall Street Journal, May 12, 2009 ---
http://online.wsj.com/article/SB124208415028908497.html

Bernanke is insanely printing hundreds of millions of dollars that do not
arise from taxes or borrowingWe remember that 2003 debate because it turns out
we played a part in it. The Fed recently released the transcripts of its 2003
FOMC meetings, and what a surprise to find aJournal
editorialthe subject of an insider rebuttal from
none other than Ben Bernanke, then a Fed Governor and now Chairman. We had run
an editorial on monetary policy on the same day as the Dec. 9, 2003 FOMC
meeting, and Mr. Bernanke clearly didn't take well to our warning about "Speed
Demons at the Fed."We reprint nearby both Mr.
Bernanke's commentsand our
editorialfrom that day. Readers can judge who got
the better of the argument, but far more important is what Mr. Bernanke's
reasoning tells us about the Fed today. Our guess is that it won't reassure
holders of dollar assets"Bernanke at the Creation: What the Fed Chairman said at the
onset of the credit bubble, and the lesson for today," The Wall Street
Journal, June 23, 2009 ---
http://online.wsj.com/article/SB124572415681540109.html

Can you see why I believe this is a sucker's rally?The stock market still has big hurdles to clear. You
can have a jobless recovery, but you can't have a profitless recovery. Consider:
Earnings are subpar (and may get worse with more concessions to labor
unions), Treasury's last auction was a bust because of
weak demand, the dollar is suspect, the stimulus is pork, the latest budget
projects a $1.84 trillion deficit, the administration is berating investment
firms and hedge funds saying "I don't stand with them," California is dead
broke, health care may be nationalized, cap and trade will bump electric bills
by 30% . . . Shall I go on? Until these issues are resolved, I don't see the
stock market going much higher. I'm not disagreeing with the Fed's policies --
but I won't buy into a rising stock market based on them. I'm bullish when I see
productivity driving wealth. Andy Kessler, "Was It a Sucker's
Rally? You can have a jobless recovery but you can't have a profitless one,"
The Wall Street Journal, May 12, 2009 ---
http://online.wsj.com/article/SB124208415028908497.html
Jensen Comment
Nobody can be counted on to predict the stock market and the unpredictable
shocks that affect it. One shock that will ultimately drive equity market prices
up is inflation, and inflation is inevitable with Obama's annual egalitarian
deficits of $2 trillion or more. One problem with inflation is that nobody can
accurately predict just when the stock market will make huge upward moves for
Zimbabwe-like inflation. A second problem is that paper profits on equity are
not real profits. They're probably losses in spending power. If these huge Obama
deficits continue in the future, both debt and equity will have to be indexed
for inflation when investors cease to be suckers. For many years investors in
high-inflation nations like Brazil stopped being suckers. Virtually all security
investments in Brazil are indexed for inflation.

America, what is happening to you?“One thing seems probable to me,” said Peer Steinbrück,
the German finance minister, in September 2008....“the United States will lose
its status as the superpower of the global financial system.” You don’t have to
strain too hard to see the financial crisis as the death knell for a
debt-ridden, overconsuming, and underproducing American empire.Richard Florida, "How the Crash Will
Reshape America," The Atlantic, March 2009 ---
http://www.theatlantic.com/doc/200903/meltdown-geography

Once the spigot is turned on it's almost never turned off: That's
how special appropriations become entitlements
Several university presidents and higher-education officials went to Capitol
Hill on Tuesday to thank lawmakers for committing more ($21.5
billion) funds for scientific research, but they
worried about what might happen to their budgets if that commitment didn't
continue. Paul Baskey, "Universities Are Wary
of Drawbacks to a Huge Boost in Federal Spending," Chronicle of Higher
Education, March 25, 2009 ---
http://chronicle.com/daily/2009/03/14470n.htm?utm_source=at&utm_medium=en
Jensen Comment
This is the same argument that will be raised by virtually all recipients of the
2009 massive Stimulus (Recovery) Act handouts to states, education/research
institutions, welfare programs, public works projects, etc. Once the spigot is
turned on such handouts are hard to stop in future budget years. They become
entitlements that will make President Obama's promise to reduce the Year 2012
budget deficit a complete and utter failure. Both logic and sob stories make it
virtually impossible to turn the spigots off once they've been turned on. This
is one of the common problems of budgeting in general except for Zero-Based
Budgeting that almost never takes place in industry and probably has never taken
place in state and federal governments.
Bob Jensen's threads on the entitlements disaster are at
http://www.trinity.edu/rjensen/Entitlements.htm

Tim Geithner Draws a Big Laugh and Lots of Sighs In ChinaU.S. Treasury Secretary Timothy Geithner on Monday
reassured the Chinese government that its huge holdings of dollar assets are
safe and reaffirmed his faith in a strong U.S. currency. A major goal of
Geithner's maiden visit to China as Treasury chief is to allay concerns that
Washington's bulging budget deficit and ultra-loose monetary policy will fan
inflation, undermining both the dollar and U.S. bonds. China is the biggest
foreign owner of U.S. Treasury bonds. U.S. data shows that it held $768 billion
in Treasuries as of March, but some analysts believe China's total U.S.
dollar-denominated investments could be twice as high. "Chinese assets are very
safe," Geithner said in response to a question after a speech at Peking
University, where he studied Chinese as a student in the 1980s. His answer drew
loud laughter from his student audience, reflecting skepticism in China about
the wisdom of a developing country accumulating a vast stockpile of foreign
reserves instead of spending the money to raise living standards at home. Glenn Somerville, Reuters,
June 1, 2009 ---
Click Here

The salary of the chief
executive of a large corporation is not a market award for achievement. It is
frequently in the nature of a warm personal gesture by the individual to
himself.John Kenneth Galbraith ---
Click Here

Instead of adding more regulating agencies, I think
we should simply make the FBI tougher on crime and the IRS tougher on cheats

Our Main Financial Regulating Agency: The SEC Screw
Everybody Commission
One of the biggest regulation failures in history is the way the SEC failed to
seriously investigate Bernie Madoff's fund even after being warned by Wall
Street experts across six years before Bernie himself disclosed that he was
running a $65 billion Ponzi fund.

I’m deeply suspicious that there was possibly too much
“experience” of a different type as well as “inexperience” cited as the main
cause of the SEC’s negligence. The Inspector General’s Report leaves a lot to be
desired.

Swanson Acknowledged in
Testimony that If He Had Carefully Reviewed the Complaint, He Would Have
Investigated

Additional Red Flags That Were
Raised Swanson stated the Hedge Fund Manager’s complaint and the 2001
articles mean something different to him today than they did at the time of
the examination in 20032004, noting, “I didn’t know anything, very little
anyway, about hedge funds and mutual funds and how they operated.” Id. at p.
39. Swanson admitted that to someone who understood the hedge fund world,
Madoff’s failure to charge money management fees “would probably be a little
surprising.” Id. at p. 37. Swanson now reads the Hedge Fund Manager’s
complaint to “indicate to me … [BMIS] may be not trading as much in options
as they’re saying they’re doing,” and the red flag about the auditor to
“signal some level of a lack of independence with respect to the auditor.”
Id. at pgs. 37-38. Swanson testified that if he had reviewed the complaint,
he would have wanted to look into the auditor issue. Swanson Testimony Tr.
at p. 50. McCarthy and Donohue also thought that the allegation that the
auditor was a related party to the principal was noteworthy and something
that should have been followed up upon. Donohue Testimony Tr. at p. 42;
McCarthy Testimony Tr. at p. 58. As Donohue explained, “His statement that
the auditor of the firm is a related party to the principal would indicate
that there are potential conflicts with the firm and the auditor.” Donohue
Testimony Tr. at p. 42. However, during the course of the examination, the
exam team did not examine whether the auditor of the firm was a related
party to the principal.

. . .

ALLEGATIONS OF CONFLICT OF
INTEREST OR IMPROPER INFLUENCE ARISING FROM THE RELATIONSHIP BETWEEN ERIC
SWANSON AND SHANA MADOFF (Pages 389-404)

After his sworn testimony
on June 19, 2009, Swanson provided supplemental information to the
Office of the Inspector General, stating that he had a vague
recollection that, “prior to 2005, he and Mr. McCarthy discussed the
appropriateness of working on matters involving Madoff in light of their
participation in the compliance breakfasts, and that neither he nor
McCarthy determined that they should be recused.” Letter dated June 19,
2009 from Michael Wolk, Counsel to Swanson, to IG Kotz, at p. 2, at
Exhibit 183. Swanson also stated that he “took comfort in the fact that
Lori Richards, Director, Office of Compliance Inspections and
Examinations, was aware that the breakfasts were sponsored by the
Securities Industry Association (SIA).” Id.

Jensen Comment
This part of the Inspector General's report relies a lot upon Eric Swanson's
claims of not being able to remember much about his early-on relationships
with Shana Madoff. About this part of the Report I am very suspicious.
However, early news accounts are also somewhat inconsistent.

Shana Madoff, whose uncle Bernie Madoff stands
accused of defrauding investors of $50 billion (later raised to over
$65 billion), is the wife of Eric Swanson, a former
top lawyer at the Securities and Exchange Commission. A goy, but
well-placed!

So well-placed that SEC chairman Christopher Cox is
now elaborately raising his eyebrows about the relationship — especially
since Shana Madoff worked as the compliance lawyer at Bernard L. Madoff
Investment Securities, and met Swanson at a trade association event. . . .

Swanson resigned from the SEC in 2006, and the
couple married in 2007. But they clearly dated for a while before that.

Some have suggested that Shana Madoff is a
"shopaholic." So not technically true! Why, she married the manager of a
men's clothing store in 1997, but that didn't work out. A 2004 New York
profile detailed her simultaneous affection for Narciso Rodriguez and
aversion to actually going out and shopping. Instead of trying on clothes at
the store, she had salespeople messenger the entire collection to her
office, and charge her only for what she didn't return. The article mentions
her having a boyfriend. Was that Swanson, whom one SEC colleague said
conducted a review of Madoff's firm in 1999 and 2004?

A spokesman for Swanson — they get flacks quickly
these days, don't they — told ABC News that he "did not participate in any
inquiry of Bernard Madoff Securities or its affiliates while involved"
(it was later shown that he was very involved in the Madoff
"investigation" while at the SEC) with Shana Madoff.
How convenient!

But that could be said about pretty much all of his
coworkers. The SEC first fielded complaints about the Madoff firm in 1999,
but never opened a formal investigation that would have allowed it to
subpoena records. In 2006, Bernard Madoff registered as an investment
advisor with the SEC, but the agency never conducted a standard review. Are
you beginning to get a picture of why Shana Madoff, who was charged with
keeping the company out of trouble with regulators, was so busy she couldn't
even go shopping?

Swanson was at the commission in 2003 when the
agency was examining the Madoff firm. More
importantly, he was also part (leader) of the SEC
team that was conducting the actual inquiry into the firm . . .
What does all this mean? Nothing, according to Shana
Madoff or her husband, whom she married in 2007. A spokesman for Shana Madoff
and one for Swanson confirm that both knew each other professionally during the
time of the examination."Madoff Victims Claim Conflict of Interest at SEC," CNBC, December 15,
2008 ---
http://www.cnbc.com/id/28242487

In a damning reporton the S.E.C.’s performance,
the agency’s inspector general, H. David Kotz, said numerous “red flags” had
been missed by the agency, including some warnings sounded by journalists,
well before Mr. Madoff’s
Ponzi schemeimploded in 2008.

Mr. Kotz concluded that, “despite numerous credible
and detailed complaints,” the S.E.C. never properly investigated Mr. Madoff
“and never took the necessary, but basic, steps to determine if Madoff was
operating a Ponzi scheme.”

“Had these efforts been made with appropriate
follow-up at any time beginning in June of 1992 until December 2008, the
S.E.C. could have uncovered the Ponzi scheme well before Madoff confessed,”
the report concluded.

That Mr. Madoff’s scheme, estimated to have fleeced
as much as $65 billion from investors who ranged from the famous to
middle-class people who entrusted him with their life savings, was not
caught earlier was not because of his cleverness, the report said. Rather,
it was because the S.E.C. fumbled three agency exams and two investigations
because of inexperience, incompetence and lack of internal communications.

Shana Madoff, whose uncle Bernie Madoff stands
accused of defrauding investors of $50 billion (later raised to over
$65 billion), is the wife of Eric Swanson, a former
top lawyer at the Securities and Exchange Commission. A goy, but
well-placed!

So well-placed that SEC chairman Christopher Cox is
now elaborately raising his eyebrows about the relationship — especially
since Shana Madoff worked as the compliance lawyer at Bernard L. Madoff
Investment Securities, and met Swanson at a trade association event. (Can
you imagine what a swinging scene that was?)

Swanson resigned from the SEC in 2006, and the
couple married in 2007. But they clearly dated for a while before that.

Some have suggested that Shana Madoff is a
"shopaholic." So not technically true! Why, she married the manager of a
men's clothing store in 1997, but that didn't work out. A 2004 New York
profile detailed her simultaneous affection for Narciso Rodriguez and
aversion to actually going out and shopping. Instead of trying on clothes at
the store, she had salespeople messenger the entire collection to her
office, and charge her only for what she didn't return. The article mentions
her having a boyfriend. Was that Swanson, whom one SEC colleague said
conducted a review of Madoff's firm in 1999 and 2004?

A spokesman for Swanson — they get flacks quickly
these days, don't they — told ABC News that he "did not participate in any
inquiry of Bernard Madoff Securities or its affiliates while involved"
(it was later shown that he was veru involved in the Madoff
"investigation" while at the SEC) with Shana Madoff.
How convenient!

But that could be said about pretty much all of his
coworkers. The SEC first fielded complaints about the Madoff firm in 1999,
but never opened a formal investigation that would have allowed it to
subpoena records. In 2006, Bernard Madoff registered as an investment
advisor with the SEC, but the agency never conducted a standard review. Are
you beginning to get a picture of why Shana Madoff, who was charged with
keeping the company out of trouble with regulators, was so busy she couldn't
even go shopping?

Swanson was at the commission in 2003 when the
agency was examining the Madoff firm. More
importantly, he was also part of the SEC team that was conducting the actual
inquiry into the firm . . . What does all
this mean? Nothing, according to Shana Madoff or her husband, whom she married
in 2007. A spokesman for Shana Madoff and one for Swanson confirm that both knew
each other professionally during the time of the examination."Madoff Victims Claim Conflict of Interest at SEC," CNBC, December 15,
2008 ---
http://www.cnbc.com/id/28242487

Between 2002 and 2008 Harry Markopolos repeatedly told
(with indisputable proof) the Securities and Exchange Commission that Bernie
Madoff's investment fund was a fraud. Markopolos was ignored and, as a result,
investors lost more and more billions of dollars. Steve Kroft reports.

I'm really surprised that the SEC survived after Chris
Cox messed it up so many things so badly.

As Far as Regulations Go

An annual report issued by
the Competitive Enterprise Institute (CEI) shows that the U.S. government
imposed $1.17 trillion in new regulatory costs in 2008. That almost equals the
$1.2 trillion generated by individual income taxes, and amounts to $3,849 for
every American citizen. According the 2009 edition of Ten Thousand Commandments:
An Annual Snapshot of the Federal Regulatory State, the government issued 3,830
new rules last year, and The Federal Register, where such rules are listed,
ballooned to a record 79,435 pages. “The costs of federal regulations too often
exceed the benefits, yet these regulations receive little official scrutiny from
Congress,” said CEI Vice President Clyde Wayne Crews, Jr., who wrote the report.
“The U.S. economy lost value in 2008 for the first time since 1990,” Crews said.
“Meanwhile, our federal government imposed a $1.17 trillion ‘hidden tax’ on
Americans beyond the $3 trillion officially budgeted” through the regulations.Adam Brickley,
"Government Implemented Thousands of New Regulations Costing $1.17 Trillion in
2008," CNS News, June 12, 2009 ---
http://www.cnsnews.com/public/content/article.aspx?RsrcID=49487

Jensen Comment
I’m a long-time believer that industries being regulated end up controlling the
regulating agencies. The records of Alan Greenspan (FED) and the SEC from Arthur
Levitt to Chris Cox do absolutely nothing to change my belief ---
http://www.trinity.edu/rjensen/FraudRotten.htm

How do industries leverage the regulatory agencies?
The primary control mechanism is to have high paying jobs waiting in industry
for regulators who play ball while they are still employed by the government. It
happens time and time again in the FPC, EPA, FDA, FAA, FTC, SEC, etc. Because so
many people work for the FBI and IRS, it's a little harder for industry to
manage those bureaucrats. Also the FBI and the IRS tend to focus on the worst of
the worst offenders whereas other agencies often deal with top management of the
largest companies in America.

Why Obama's Big Spending, Big Taxing Regime Will Cripple the U.S. EconomyBefore any article on savings and investment can
really make sense, it must first define what savings and investment really mean.
Saving is the process of transforming present goods into future goods. Present
goods are consumption goods and future goods are capital goods. When we save, we
transfer purchasing power from consumption to the production of capital goods,
many of which will then be used to produce more capital goods. (This is why
growth is sometimes called forgone consumption.) Investment in more capital (the
material means of production) makes for increased future consumption, i.e.,
higher living standards. It needs little imagination to realise that taxing
savings amounts to taxing future living standards. What needs to be remembered
is that when defined in real terms, investment and savings are (a) always equal
and (b) saving is clearly the only means by which resources can be directed from
consumption to investment. To put it another way: The function of savings is to
redirect resources from the production of consumption goods to the production of
capital goods. "Why Obama's Big Spending, Big Taxing Regime Will Cripple the
U.S. Economy," Seeking Alpha, March 23, 2009 ---
http://seekingalpha.com/article/127312-why-obama-s-big-spending-big-taxing-regime-will-cripple-the-u-s-economy

Not a single county in the entire state
(California) voted for the tax-and-spend propositions
on yesterday's referendum ballot, not even the peculiar folks who live in Nancy
Pelosi's far-left 8th Congressional District who persist in sending the Wicked
Witch of the West to the Nation's Capitol to wage war on the CIA and the
nation's taxpayers. The only measure voters did approve was one to freeze
salaries of senior public officials during budget emergencies. Michael Reagan, "Terminating the
Terminator," Townhall, May 20, 2009 ---
http://townhall.com/columnists/MichaelReagan/2009/05/20/terminating_the_terminator
Jensen Comment
What's worse in many respects is that California voters sent a message to
President Obama that taxing the middle class (the only way to raise serious
deficit-cutting revenue) to halt deficit-induced halt hyperinflation of the U.S.
dollar will not be supported by voters.
See
http://townhall.com/columnists/MattTowery/2009/05/21/california,_here_we_come

A democracy cannot exist as a permanent form of
government. It can only exist until the voters discover that they can vote
themselves largesse from the public treasury. From that moment on, the majority
always votes for the candidates promising the most benefits from the public
treasury, with the result that a democracy always collapses over loose fiscal
policy, always followed by a dictatorship.Alexander Tyler. 1787 - Tyler was a Scottish history professor that had
this to say about 2000 years after "The Fall of the Athenian Republic" and about
the time our original 13 states adopted their new constitution.
As quoted at
http://www.babylontoday.com/national_debt_clock.htm (where the debt clock in
real time is a few months behind)The National Debt Amount This Instant (Refresh your browser for
updates by the second) ---
http://www.brillig.com/debt_clock/

America, what is happening to you?“One thing seems probable to me,” said Peer Steinbrück,
the German finance minister, in September 2008....“the United States will lose
its status as the superpower of the global financial system.” You don’t have to
strain too hard to see the financial crisis as the death knell for a
debt-ridden, overconsuming, and underproducing American empire . . . Richard Florida, "How the Crash Will
Reshape America," The Atlantic, March 2009 ---
http://www.theatlantic.com/doc/200903/meltdown-geography

The inherent vice of capitalism is the unequal sharing of the blessings. The
inherent blessing of socialism is the equal sharing of misery.Winston Churchill

(Good thing Obama sent Churchill's bust back to the U.K. from the Oval Office
and replaced it with a bust of Lincoln who wrote that Government should print
all the money it needs without borrowing)

The government should create, issue, and circulate
all the currency and credits needed to satisfy the spending power of the
government and the buying power of consumers. By adoption of these principles,
the taxpayers will be saved immense sums of interest. Money will cease to be
master and become the servant of humanity.Abraham Lincoln (I wonder why this
just does not work in Zimbabwe where Robert Mugabe adopted Lincoln's fiscal
policy?)

The Abraham Lincoln School of Finance in Action
Zimbabwe's central bank will introduce a 100 trillion Zimbabwe dollar banknote,
worth about $33 on the black market, to try to ease desperate cash shortages,
state-run media said on Friday. KyivPost,
January 16, 2009 ---
http://www.kyivpost.com/world/33522

Who stands between the Obama and the Abraham Lincoln School of Finance?
If China won't lend trillions more to the U.S., Obama may have to print those
trillions of dollars: Watch inflation/trade deficits soar like a NASA
rocketThe Chinese prime minister, Wen Jiabao, expressed
unusually blunt concern on Friday about the safety of China’s $1 trillion
investment in American government debt, the world’s largest such holding, and
urged the Obama administration to provide assurances that the securities would
maintain their value in the face of a global financial crisis. Michael Wines and Keith Bradsher,
"China’s Leader Says He Is ‘Worried’ Over U.S. Treasuries," The New York
Times, March 13, 2009 ---
http://www.nytimes.com/2009/03/14/world/asia/14china.html?_r=1&hp

America, what is happening to you?“One thing seems probable to me,” said Peer Steinbrück,
the German finance minister, in September 2008....“the United States will lose
its status as the superpower of the global financial system.” You don’t have to
strain too hard to see the financial crisis as the death knell for a
debt-ridden, overconsuming, and underproducing American empire . . . Richard Florida, "How the Crash Will
Reshape America," The Atlantic, March 2009 ---
http://www.theatlantic.com/doc/200903/meltdown-geography

And while you are at it, you might read another book
published the same year as Hayek's book was: The Great Transformation by
Karl Polanyi. It is Polanyi who is truly in the tradition of Adam Smith in that
he incorporates ethics and sociological considerations into his economics. Smith
was a moral philosopher before he was an economist. Hayek was used as a
spokesperson by the ultra-conservative anti-Keynesians of the time. Life
magazine even put out a cartoon version of Hayek's book. Academics might want to
get a fuller picture and read both Polanyi and Hayek to understand two major
currents of thought at the time. Sue Ravenscroft, Iowa State University

The US government is on a “burning platform” of
unsustainable policies and practices with fiscal deficits, chronic healthcare
underfunding, immigration and overseas military commitments threatening a crisis
if action is not taken soon.David M. Walker, Former Chief
Accountant of the United States ---
http://www.financialsense.com/editorials/quinn/2009/0218.html
Also see his dire warnings on CBS Sixty Minutes on the unbooked national debt
for entitlements (over five times the booked national debt and soaring with new
entitlements) ---
http://www.trinity.edu/rjensen/entitlements.htm

Question
What caused the credit crisis and why can't credit be unlocked after throwing
over $1 trillion at the big banks?Great answers on Video --- this is a
must-see video for you, your family, and your students who want to understand
these banking failures
The Short and Simple Video About What Caused the Credit Crisis ---
http://vimeo.com/3261363
Also at
http://www.youtube.com/watch?v=Q0zEXdDO5JU
Ed Scribner forwarded the above links

Questions
Although all 50 states are in deep financial troubles, what state is in the
worst shape at the moment and is unable to pay its bills?
Hint: The state in deepest trouble is not California, although California is in
dire straights!

How did accountants hide the pending
disasters?

Watch the Video
This module on 60 Minutes on December 19 was one of the most worrisome episodes
I've ever watched
It appears that a huge number of cities and towns and some states will default
on bonds within12 months from now
"State Budgets: The Day of Reckoning Steve Kroft Reports On The Growing
Financial Woes States Are Facing," CBS Sixty Minutes, December 19, 2010 ---
http://www.cbsnews.com/stories/2010/12/19/60minutes/main7166220.shtml

The problem with that, according to Wall Street
analyst Meredith Whitney, is that no one really knows how deep the holes
are. She and her staff spent two years and thousands of man hours trying to
analyze the financial condition of the 15 largest states. She wanted to find
out if they would be able to pay back the money they've borrowed and what
kind of risk they pose to the $3 trillion municipal bond market, where state
and local governments go to finance their schools, highways, and other
projects.

"How accurate is the financial information that's
public on the states? And municipalities," Kroft asked.

"The lack of transparency with the state disclosure
is the worst I have ever seen," Whitney said. "Ultimately we have to use
what's publicly available data and a lot of it is as old as June 2008. So
that's before the financial collapse in the fall of 2008."

Whitney believes the states will find a way to
honor their debts, but she's afraid some local governments which depend on
their state for a third of their revenues will get squeezed as the states
are forced to tighten their belts. She's convinced that some cities and
counties will be unable to meet their obligations to municipal bond holders
who financed their debt. Earlier this year, the state of Pennsylvania had to
rescue the city of Harrisburg, its capital, from defaulting on hundreds of
millions of dollars in debt for an incinerator project.

"There's not a doubt in my mind that you will see a
spate of municipal bond defaults," Whitney predicted.

Asked how many is a "spate," Whitney said, "You
could see 50 sizeable defaults. Fifty to 100 sizeable defaults. More. This
will amount to hundreds of billions of dollars' worth of defaults."

Municipal bonds have long been considered to be
among the safest investments, bought by small investors saving for
retirement, and held in huge numbers by big banks. Even a few defaults could
affect the entire market. Right now the big bond rating agencies like
Standard & Poor's and Moody's, who got everything wrong in the housing
collapse, say there's no cause for concern, but Meredith Whitney doesn't
believe it.

"When individual investors look to people that are
supposed to know better, they're patted on the head and told, 'It's not
something you need to worry about.' It'll be something to worry about within
the next 12 months," she said.

No one is talking about it now, but the big test
will come this spring. That's when $160 billion in federal stimulus money,
that has helped states and local governments limp through the great
recession, will run out.

The states are going to need some more cash and
will almost certainly ask for another bailout. Only this time there are no
guarantees that Washington will ride to the rescue.

Question
Who more than anybody else is at fault for wiping out shareholders in AIG, Bear
Stearns, Merrill Lynch, CitiBank, Bank of America, Washington Mutual, Fannie
Mae, Freddie Mack, etc.Answers
I primarily blame the CPA auditors, internal auditors, and credit rating
agencies that failed to disclose the off-balance-sheet risks that fee-loving
bankers had created. The auditors and credit rating agencies have a fiduciary
and professional responsibility to disclose to investors the extent of looming
uncollectable investments. For many years auditors have been knowingly
understating banks' bad debt risks and failing to warn investors about such
banking risks. I also think auditors, along with credit rating agencies, knew
full well about the financial risks of their huge clients but were afraid to
jeopardize their fees by blowing whistles.

Question
What more than anything else saved United Airlines and who is primarily at fault
for wiping out the shareholders of United Airlines in 2002?Answer
In December 2002 United Airlines filed Chapter 11 Bankruptcy. In order to get
United's airplanes back in the air, the single most important saving device was
to have Uncle Sam's taxpayers take over the lifetime retirement obligations to
be paid to United's retired pilots, flight attendants, mechanics, passenger
agents, and ground crews. This saved United Airlines with the help of some major
wage concessions of existing employees who decided that keeping their jobs was
the most important thing to them.

Once again the auditors are primarily at fault for not warning investors soon
enough that United Airlines was not a viable going concern and would not be able
to meet its unbooked liabilities called Off-Balance-Sheet-Financing (OBSF) by
accountants. If investors had been warned years earlier, the stock market
would've forced United Airlines to become more serious about pricing and funding
of retirement obligations. But since investors were not forewarned by the
auditors and credit rating agencies, the equity holders (many of them United
Airlines employees) got wiped out by the 2002 declaration of bankruptcy.

Question
What more than anything else will save General Motors in 2009 and who is
primarily at fault for wiping out the shareholders of General Motors?

In 2009 or 2010 filed General Motors will most likely declare Chapter 11
Bankruptcy. It will be Deja Vu United Airlines. In order to get GM's vehicles
back on the road, the single most important saving device was to have Uncle
Sam's taxpayers take over the retirement obligations (pensions and health care
obligations) to be paid to GM's retired management and factory workers and GMAC
retired employees as well. This will save GM with the help of some major wage
concessions of existing GM employees who eventually decide that keeping their
jobs was the most important thing to them.

Once again the auditors are primarily at fault for not warning investors soon
enough that General Motors was not a viable going concern and would not be able
to meet its unbooked liabilities called Off-Balance-Sheet-Financing (OBSF). If
investors had been warned years earlier, the stock market would've forced
General Motors to become more serious about pricing and funding of retirement
obligations. But since investors were not forewarned by the auditors and credit
rating agencies, the equity holders (many of them being huge investment funds)
got wiped out by the forthcoming 2009 declaration of bankruptcy.

In fairness, the accountants did give more warning about OBSF unfunded
retirement obligations in GM's case relative the United Airlines. Accountants
did disclose some years ago that about $1,500 of each new vehicle sold went
toward current funding of for retirement and health care of GM's retired
workers. It's been widely known for some time that GM's retirement obligations
were badly underfunded. What made it especially difficult for GM is that it's
major foreign competitors were making longer-lasting vehicles that beat GM
prices. The reason Toyota, Subaru, Nissan, etc. could undercut GM prices is that
these foreign automakers did not have the serious unbooked OBSF obligations that
GM carried on its back.

Question
What are the two secret numbers that you will never hear mentioned by Uncle
Sam's current leaders like President Obama, House Speaker Pelosi, and Senate
Leader Reid?Answer
They will never mention the extent of Uncle Sam's unbooked OBSF liabilities.
Accountants have no accurate estimates of these liabilities, but the former
Chief Accountant of the United States, David Walker, estimates that these are
about $60 trillion at the moment. They may well be $100 trillion in four years
if Congress is successful in legislating tens of trillions of dollars in new
entitlements for education, energy, welfare, and health care.

Uncle Sam's leaders are now focusing our attention on problems with the annual
spending deficit (which may well approach $ trillion at the end of 2009) and the
booked National Debt (which may well approach $12 trillion by the end of 2009).
But these booked items will not break the back of Uncle Sam. What will break the
back of Uncle Sam is what broke the back of United Airlines and General Motors.
It's the unbooked OBSF debt which the companies, auditors, and credit rating
agencies tried to keep secret.

Uncle
Sam saved United Airlines by taking over United's OBSF retirement debt. Uncle
Sam will probably do the same for GM, Ford, and Chrysler unfunded OBSF debt. But
who will save Uncle Sam from its $60-$100 trillion of unfunded and unbooked OBSF
debt?
Answer
Only the Abraham Lincoln School of Finance (see Lincoln’s quote below) will save
Uncle Sam from its unsustainable OBSF

The US government is on a “burning platform” of unsustainable
policies and practices with fiscal deficits, chronic healthcare underfunding,
immigration and overseas military commitments threatening a crisis if action is
not taken soon.
David M. Walker,
Former Chief Accountant of the United States ---
http://www.financialsense.com/editorials/quinn/2009/0218.html
Also see his dire warnings on CBS Sixty Minutes on the unbooked national debt
for entitlements (over five times the booked national debt and soaring with new
entitlements) ---
http://www.trinity.edu/rjensen/entitlements.htm

A democracy cannot exist as a permanent form of government. It can only exist
until the voters discover that they can vote themselves largesse from the public
treasury. From that moment on, the majority always votes for the candidates
promising the most benefits from the public treasury, with the result that a
democracy always collapses over loose fiscal policy, always followed by a
dictatorship.Alexander Tyler. 1787 - Tyler was a Scottish history professor that had
this to say about 2000 years after "The Fall of the Athenian Republic" and about
the time our original 13 states adopted their new constitution.
As quoted at
http://www.babylontoday.com/national_debt_clock.htm
(where the debt clock in real time is a few months behind)
The National Debt Amount This Instant (Refresh your browser for updates by the
second) ---
http://www.brillig.com/debt_clock/

America,
what is happening to you?“One thing seems probable to me,” said Peer
Steinbrück, the German finance minister, in September 2008....“the United States
will lose its status as the superpower of the global financial system.” You
don’t have to strain too hard to see the financial crisis as the death knell for
a debt-ridden, overconsuming, and underproducing American empire . . .
Richard Florida,
"How the Crash Will Reshape America," The Atlantic, March 2009 ---
http://www.theatlantic.com/doc/200903/meltdown-geography

The inherent vice of capitalism is the unequal sharing of the blessings. The
inherent blessing of socialism is the equal sharing of misery.Winston Churchill

(Good thing Obama sent Churchill's bust back to the U.K. from the Oval Office
and replaced it with a bust of Lincoln who wrote that Government should print
all the money it needs without borrowing)

From the Abraham Lincoln School of Finance
The government should create, issue, and circulate all the currency and credits
needed to satisfy the spending power of the government and the buying power of
consumers. By adoption of these principles, the taxpayers will be saved immense
sums of interest. Money will cease to be master and become the servant of
humanity.Abraham Lincoln
(I wonder why this just does not work in Zimbabwe where Robert Mugabe adopted
Lincoln's fiscal policy?)

For
the sake of future America, we’d better hope that Lincoln was correct. But
Lincoln’s fiscal policy sure did not work for Zimbabwe.

Facing mounting criticism of a spending package packed
with billions of dollars in earmarks, the Obama administration made a vow
Sunday: This president will bring a halt to pork-laden bills. "Obama budget director: We'll cut pork after '09 spending bill,"
CNN, March 8, 2009 ---
http://www.cnn.com/2009/POLITICS/03/08/obama.earmarks/index.html
Jensen Comment
If you believe this, I have a great deal on ocean front property in Arizona just
for you. I'll also let you have the Brooklyn Bridge for $5,000.

Fannie Mae and Freddie Mac, the two troubled
companies at the heart of the nation’s mortgage market, are set to pay their
employees “retention bonuses” totaling $210 million, despite calls from
lawmakers to cancel the payments. The bonuses, which were made public on Friday,
were defended by the companies’ federal regulator, James B. Lockhart, who said
he intended to let them proceed , , , Mr. Lockhart declined to discuss his
conversations with the White House, which declined to comment on Friday. “This
is a de facto White House endorsement of these payments, which is a little odd
considering that everyone spent days talking about how they were shocked by the
bonuses given to A.I.G.,” said Karen Shaw Petrou, a managing partner at Federal
Financial Analytics, a consulting firm in Washington and a longtime observer of
the companies. “It’s also a tempest in a teapot. We should worry less about $210
million in bonuses, and more about the fact that these companies are sitting
atop $5 trillion of risks, and if they stumble, the American economy could
disappear.” Charles Duhigg, "Big Bonuses at
Fannie and Freddie Draw Fire," The New York Times, April 3, 2009 ---
http://www.nytimes.com/2009/04/04/business/04bonus.html?_r=1

New restrictions proposed for ratings agencies --
including Moody's, Fitch and Standard & Poor's -- could have unintended
consequences, warn experts in the United States. Europe, however, has clamped
down on the agencies, whose stamps of approval on a broad spectrum of subprime
mortgage securities helped pave the way to the credit crash of 2007 and the
continuing global recession. "Reforming the Ratings Agencies: Will the U.S. Follow Europe's
Tougher Rules?"Knowledge@Wharton
, May 27, 2009 ---
http://knowledge.wharton.upenn.edu/article.cfm?articleid=2242

Dear Mr. Buffett,
chronicles the agency problems, poor regulations, and participants which led to
the current financial crisis. Janet accomplishes this herculean task by
capitalizing on her experiences with derivatives, Wall St, and her relationship
with Warren Buffett. One wonders how she managed to pack so much material in
such few pages!

Unlike many books which only analyze past events, Dear Mr.
Buffett, offers proactive advice for improving financial markets. Janet is
clearly very concerned about protecting individual rights, promoting honesty,
and enhancing financial integrity. This is exactly the kind of character we
should require of our financial leaders.

Business week once called Janet the Cassandra of Credit
Derivatives. Without a doubt Janet should have been listened to. I’m confident
that from now on she will be.

Closing thoughts

Rather than a complicated book on financial esoterica, Janet has
created a simple guide to understanding the current crisis. This book is a must
read for all students of finance, economics, and business. If you haven’t read
this book, please do so.

Warning –This book is likely to infuriate you, and that’s a good
thing! Janet provides indicting evidence and citizens may be tempted to
initiate vigilante like witch trials. Please
consult with your doctor before taking this financial medication.

I am reading Dear Mr. Buffett, What an Investor
Learns 1,269 Miles from Wall Street, by Janet Tavakoli. I am just about
finished with the book. I am thinking about giving a copy of the book to
students who perform well in my upper-level financial reporting classes.

I agree with the reviewer’s comments about
Tavakoli’s book. Her explanations are clear and concise and do not require
expertise in finance or financial derivatives in order to understand what
she (or Warren Buffet) says. She explains the underlying problems of the
financial meltdown with ease. Tavakoli does not blow you over with “finance
BS.” She does in print what Steve Kroft does in the 60 Minutes story.

Tavakoli delivers a unique perspective throughout
the book. She looks through the eyes of Warren Buffett and explains issues
as Buffett sees them, while peppering the discussion with her experience and
perspective.

The reviewer is correct. Tavakoli lets the finance
world, along with accountants, attorneys, bankers, Congress, and regulators,
have it with both barrels!

Tavakoli’s book is the highlight of my summer
reading.

Best wishes,

Rick Lillie

Rick Lillie, MAS, Ed.D., CPA Assistant Professor of
Accounting Coordinator - Master of Science in Accountancy (MSA) Program
Department of Accounting and Finance College of Business and Public
Administration CSU San Bernardino 5500 University Pkwy, JB-547 San
Bernardino, CA. 92407-2397

Steve Kroft examines the complicated financial instruments known as credit
default swaps and the central role they are playing in the unfolding economic
crisis. The interview features my hero Frank Partnoy. I don't know of
anybody who knows derivative securities contracts and frauds better than Frank
Partnoy, who once sold these derivatives in bucket shops. You can find links to
Partnoy's books and many, many quotations at
http://www.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds

For years I've used the term "bucket shop" in financial securities marketing
without realizing that the first bucket shops in the early 20th Century were
bought and sold only gambles on stock pricing moves, not the selling of any
financial securities. The analogy of a bucket shop would be a room full of
bookies selling bets on NFL playoff games.
See "Bucket Shop" at
http://en.wikipedia.org/wiki/Bucket_shop_(stock_market)

I was not aware how fraudulent the credit derivatives markets had become. I
always viewed credit derivatives as an unregulated insurance market for credit
protection. But in 2007 and 2008 this market turned into a betting operation
more like a rolling crap game on Wall Street.

AIG now says it paid out more than $454 million in
bonuses to its employees for work performed in 2008. That is nearly four times
more than the company revealed in late March when asked by POLITICO to detail
its total bonus payments. At that time, AIG spokesman Nick Ashooh said the firm
paid about $120 million in 2008 bonuses to a pool of more than 6,000 employees.
The figure Ashooh offered was, in turn, substantially higher than company CEO
Edward Liddy claimed days earlier in testimony before a House Financial Services
Subcommittee. Asked how much AIG had paid in 2008 bonuses, Liddy responded: “I
think it might have been in the range of $9 million.”Emon Javers, "AIG bonuses four times
higher than reported," Politico, May 5, 2009 ---
http://www.politico.com/news/stories/0509/22134.html

Incentives work, all right. Just look at
the way our bankers come back to bonuses, finding in every occasion a good
opportunity to cut themselves a slice of largess. Their determination is
unrelenting, monomaniacal. It's like Republicans returning to tax cuts, the
universal solution to every problem.

Some institutions, we read, are struggling
to free themselves from the TARP, because of its exuberance-chilling
compensation limits. Others have decimated their workforces, apparently so
they might continue to shower money on the favored ones. Still other
institutions have signaled that they would rather borrow at higher rates of
interest than accept the compensation limits that come with cheaper federal
loans. And certain banks are on track to return to pre-recession
compensation levels this year, according to a story last week in the New
York Times. Goldman Sachs, for example, set aside $4.7 billion for
compensation in the first quarter alone.

Another way incentives work is this: They
have kept the debate over incentives from getting off the dime for years.
There is no amount of shame that will deter the bonus class from pressing
their demand, no scandal that will put it off limits, no public outrage over
AIG or Enron or really expensive Merrill Lynch trash cans that will silence
the managers' monotonous warble: "Attract and retain top talent!"

And there is no possible objection to
inflated compensation you can make that will not be instantly maligned as
senseless populism.

In truth, however, the verdict has been in
for years. Pay for performance systems, at least as they exist in many
places, are a recipe for disaster.

What they have "incentivized" executives
to do, in countless cases, is not to perform, but to game the system, to
smooth the numbers, to take insane risks with other people's money, to do
whatever had to be done to ring the bell and send the dollars coursing their
way into the designated bank account.

It may well be true that those in our
bonus class are geniuses, but in far too many cases their fantastic brain
power is focused not on serving shareholders or guiding our economy but
simply on getting that bonus.

One might say that events of the last year
had proved this fairly conclusively.

Or one could quote the immortal words of
Franklin Raines, the onetime CEO of Fannie Mae, as they were recorded by
Business Week in 2003: "My experience is where there is a one-to-one
relation between if I do X, money will hit my pocket, you tend to see people
doing X a lot. You've got to be very careful about that. Don't just say: 'If
you hit this revenue number, your bonus is going to be this.' It sets up an
incentive that's overwhelming. You wave enough money in front of people, and
good people will do bad things."

Will they ever. They might, for example,
pull an accounting fraud of the kind Fannie Mae itself was accused of
committing in 2004, in which earnings were allegedly manipulated to, ahem,
hit certain revenue numbers and make the bonuses go bang.

They might rig the game to take the credit
-- and reap the rewards -- when good luck befalls an entire industry. If
they're bankers, they might even try to claim that their firm's recovery,
made possible by TARP money and government guarantees, was actually a fruit
of their personal ingenuity. Bring on the billions!

Of course, they will also threaten to
leave if they don't get exactly what they want. Take last week's news story
about the supersuccessful energy trading unit of Citibank, whose star trader
scored $125 million in 2005, owns a castle in Germany, and collects Julian
Schnabel paintings. This merry band of traders is apparently thinking about
a white-collar walkout should the government refuse to lift its compensation
restrictions.

At first one feels pity for Citi and its
resident geniuses, brought to these straits by the interfering hand of
government. But then it dawns on you: Should a company receiving billions of
public dollars really be gambling on speculative energy trades? After all,
the bank's ordinary, everyday deposits would have to be made good by you and
me through the FDIC should one of their bright traders pull a Nick Leeson
someday.

Besides, why is Citi so anxious to give in
to these guys? It can't be that hard to "retain top talent" when New York is
awash with unemployed bankers and traders who are no doubt anxious for a
chance to prove their own brilliance.

Here's a Wall Street solution to Wall
Street's problems: Let's offshore trading operations to lands where ethics
are more highly esteemed -- Norway, for instance. And while we're at it,
let's replace our gold-plated, Lear-jetting American CEOs with thrifty
Europeans, who may not write management books but who will do the work
better, and for a fraction of the cost.

On Friday September 14, the US government announced
the completion of the sale of AIG stock taxpayers bought during the
financial crisis bailout of the insurer. The government took in $20.7
billion for the sale and is no longer the majority owner of the company. At
the peak of the crisis, taxpayers owned almost 80% of AIG.

As we approach the four-year anniversary of the
collapse of Lehman Brothers and the rescue of A.I.G. next week, sadly,
much of the public — and people like Mr. Barofsky, as well-intentioned
as he is — are still criticizing and debating the merits of the bailout.
It’s almost become a cottage industry.

In his book, Mr. Barofsky wrote, “Treasury’s
desperate attempt to bail out Wall Street was setting the country up for
potentially catastrophic losses.”

As distasteful as the rescue effort was, it
should be clear by now that without it, we faced an economic Armageddon.
And the results thus far of bailing out the big banks, and A.I.G.,
indicate a profit.

Treasury never uses the term “profit” to describe
what taxpayers would receive. The GAO did in a report in May
when it estimated the proceeds that could be realized at various sale
prices.

I wrote in American Banker about Sorkin’s claim
that the bank bailouts prevented “financial system Armageddon” and his
debate with Barofsky. I think “profit” is not only the wrong term but an
answer to the wrong question.

It can never be proven that the crisis bailouts
saved us from financial Armageddon. That’s the logical fallacy of
asserting a claim with no way to disprove the opposite, so saying we
made a profit on the deal is the next best thing. The New
York Times’ Andrew Ross Sorkin claims,
if you combine Treasury actions and “positive returns” on Federal
Reserve activities, the Treasury is now “on a path to actually turn a
profit.” That’s where the debate starts.

Former Special Inspector General for the
Troubled Asset Relief Program Neil Barofsky says,“Not
so fast.”I
agree. If your intention is to try to prove
or disprove the government PR claims that the taxpayer has made an
accounting profit on any of the bailouts, or
even broken even, you must remember this: That’s not why the government
supposedly did what they did. And on the two counts of failing to
unfreeze credit and failing to help homeowners – how the bailouts were
justified to Congress – the government is guilty.

“Yves Smith” at Naked Capitalism also points out
that AIG enjoyed a tax benefit that negates Treasury”s claim. Who reported
that deal? Andrew Ross Sorkin in February.

In a February article, “Bending
the Tax Code, and Lifting A.I.G.’s Profit,”
Sorkin described how AIG was allowed to retain $26.2 billion of net
operating losses that should have been wiped out as a part of the rescue
of the company as well as an additional $9 billion of “unrealized loss
on investments.” That increased AIG’s fourth quarter and hence fiscal
year earnings by a remarkable $17.7 billion, which dwarfs the mere $1.6
billion its operations produced that quarter. And the article includes
this juicy bit:

Analysts at Bank of
America and JPMorgan Chase last year estimated that the tax benefits
from the losses propped up A.I.G. stock by $5 to $6 a share. Its shares
closed at $28.66 on Monday, just shy of the $29 mark that the government
says it needs to sell
its shares to break even.

General Motors, another bailout “success story” –
because saving GM supposedly averted jobs and economic disaster in Detroit –
also benefited from the IRS rule change regarding retention of net operating
loss carry forwards and “fresh start” accounting. I wrote about that in
Forbes in November of 2010.

Reporting profits means new GM doesn’t lose the
valuable deferred tax assets they carried over from old GM, thanks to a
last minute fix from the US Treasury in
September. The accountants can pull dollars from a cookie jar valuation
allowance to prop up earnings when needed.

The IPO would probably have never passed even a
minimal “smell test” by the SEC’s Division of Corporate Finance if
”fresh start accounting” hadn’t put millions
in goodwill on their balance sheet. That gave
GM a positive balance in shareholder’s equity. In a perverse example of
accounting chicanery, the better GM does the less valuable that asset
is.

Iowa Sen. Charles Grassley suggested that AIG
executives should accept responsibility for the collapse of the insurance giant
by resigning or killing themselves. The Republican lawmaker's harsh comments
came during an interview Monday with Cedar Rapids, Iowa, radio station WMT . . .
Sen. Charles Grassley wants AIG executives to apologize for the collapse of the
insurance giant — but said Tuesday that "obviously" he didn't really mean that
they should kill themselves. The Iowa Republican raised eyebrows with his
comments Monday that the executives — under fire for passing out big bonuses
even as they were taking a taxpayer bailout — perhaps should "resign or go
commit suicide." But he backtracked Tuesday morning in a conference call with
reporters. He said he would like executives of failed businesses to make a more
formal public apology, as business leaders have done in Japan. Noel Duara, "Grassley: AIG execs
should repent, not kill selves," Yahoo News, March 17, 2009 ---
http://news.yahoo.com/s/ap/20090317/ap_on_re_us/grassley_aig

AIG's bailout is getting the revisionist
treatment. The rescue hasn't been the dismal federal experience that,
say, GM's has been. Taxpayers are showing a $5 billion profit on their
53% stake in the insurer, as of yesterday's closing price.

What's more, in the last few days, the New York
Fed liquidated the last of the complex mortgage derivatives it acquired
from AIG's counterparties as part of the bailout. Such transactions and
related fees have netted the government about $18 billion.

This is good news but requires some revising of
theories of the crisis itself. The "toxic" and "shaky" housing
derivatives that got AIG in trouble turn out, even amid the worst
housing slump in 70 years, not to have been the crud many assumed they
were.

A lot of renditions skip over this part,
dismissing AIG's pre-crash mortgage activities as "reckless," thereby
making a mystery of how the refinancing of AIG could be paying off so
handsomely for taxpayers. Taxpayers are making out because they bought
valuable assets on the cheap.

This is as it should be. But let's remember how
AIG got in trouble. It wrote insurance to guarantee the very senior
portions of securities derived from underlying mortgages—that is, the
portions already designed to withstand a sizeable increase in defaults.

AIG failed not because of the failure of these
securities to keep paying as expected, but because of its own promise to
fork up cash collateral if the market price of these securities fell or
if the rating agencies downgraded what they had previously rated
Triple-A.

In the systemic panic that climaxed with the
Lehman failure, both things happened in spades, even as AIG itself no
longer could raise the cash to make good on its commitments. Some now
claim AIG could have waved off the collateral calls, citing exceptional
circumstances. But even that wouldn't have changed the fact that,
because of the panic, AIG itself was no longer trusted despite being
chock-full of good assets.

We'll never know if the company might have
finessed its way out of its jam (quite possibly its counterparties,
including Goldman Sachs, would have acted to keep AIG afloat if the
alternative of a government bailout weren't available). Instead AIG
turned to taxpayers to finance the collateral calls it couldn't finance
itself, and taxpayers took advantage.

For all the desire to name villains and blame
bad incentives for the financial crisis, notice that panic itself was
the key player. Panic is a variable about which it's disconcertingly
hard for government to do anything useful in advance.

Panic is systemic—an uncertainty or loss of
trust in how the system will behave. Here's a simple but relevant
example: What happens to the market value of mortgages if investors lose
confidence in the legal system to permit them to foreclose on borrowers
who stop paying?

We don't need to retread the history. Letting
Lehman fail was a disaster because the rescue of Bear Stearns had
conditioned the market to believe Washington wouldn't permit major
institutional failures. The mixed signals sent about Fannie and Freddie
only undermined the effort to recruit fresh capital to other financial
institutions distressed by uncertainty over the value of mortgage
securities.

AIG is the most dramatic example of the general
case. A lot of things become good or bad collateral depending on what
the government is expected to do. It's not too strong to say Washington
had to bail out AIG because the market was uncertain whether Washington
would bail out AIG. (An additional complexity we won't go into is how
the Fed's QE exercises subsequently boosted the bailout's profits.)

Let us be careful here: A host of private and
public behaviors contributed to the housing bubble and meltdown, whose
losses were destined to be felt widely. Our system has no problem
accommodating the failure of individual institutions, even very big
ones. But systemic panic always comes to the door of government. It
can't be otherwise.

Governments can try to duck this burden, as
European governments have done, only by renouncing the ability to print
money and so soiling their own credit that substituting their own credit
for the financial system's is no longer an option. Make no mistake: This
would be a real cure for too-big-to-fail if the Europeans were inclined
to let the chips fall. They're not. Instead the self-disabling
governments want Germany to supply the bailout.

Continued in article

Outrageous Bonus Frenzy

AIG now says it paid out more than $454 million in
bonuses to its employees for work performed in 2008. That is nearly four times
more than the company revealed in late March when asked by POLITICO to detail
its total bonus payments. At that time, AIG spokesman Nick Ashooh said the firm
paid about $120 million in 2008 bonuses to a pool of more than 6,000 employees.
The figure Ashooh offered was, in turn, substantially higher than company CEO
Edward Liddy claimed days earlier in testimony before a House Financial Services
Subcommittee. Asked how much AIG had paid in 2008 bonuses, Liddy responded: “I
think it might have been in the range of $9 million.”Emon Javers, "AIG bonuses four times
higher than reported," Politico, May 5, 2009 ---
http://www.politico.com/news/stories/0509/22134.html

Professor Ketz Asserts Other Comprehensive Income (OCI from FAS 130)
may be More Important to Study Than Reported Income

"Citigroup Remains in Critical Condition," by: J. Edward Ketz , SmartPros,
May 2009 ---
http://accounting.smartpros.com/x66534.xml
Note that all Citigroup dollar amounts are in millions of dollars such that
$(27,684) is really a $27,684,000,000 billion loss.

The stress tests conducted by the Fed are a farce
inasmuch as the stress isn't too strenuous. That the Fed ascertained
additional capital requirements for several banks merely points out the
obvious - the banking sector remains in serious trouble.

That the financial industry was and remains in
trouble is not revelatory to those who pay attention to fair value
measurements. Take Citigroup for instance. This firm, once a giant among
banks, now gasps for its existence.

Citi’s reported net income was $(27,684) for 2008
(all accounting numbers in millions of dollars). While this is a smelly
number, the odor grows worse when one adjusts it for various items that
bypass the income statement.

Ever since the FASB invented the comprehensive
income statement in a political move to get business enterprises to do some
accounting for items they didn’t want to disclose, I have advocated that
investors use comprehensive income instead of net income. Comprehensive
income includes relevant items that have had a real economic impact on the
business entity; therefore, investors will find these items informative.

For fiscal 2008, Citi shows unrealized losses on
its available-for-sale securities of $(10,118). It also shows a loss on the
foreign currency translation adjustment of $(6,972), a loss on its cash flow
hedges of $(2,026), and a loss for additional pension liability adjustment
of $(1,419). This makes Citi’s comprehensive income $(48,219).

But the bad news doesn’t end there. The pension
footnote (footnote 9) shows the expected rate of return is 7.75%. While this
is what is required per FAS 87, it is nonsense. Did anybody know the 2008
rate of return in (say) 2005? The FASB should get rid of such fantasyland
assumptions and require business enterprises to employ the actual rate of
return. If Citi had done so on its pension assets, it would have had an
actual return of (5.42)%, so we shall adjust downward the 2008 income by
another $1,370.

The most interesting item is Citi’s move with
respect to its investments. It reports debt securities in its 2007
held-to-maturity portfolio of only $1. By year end 2008, however, this
amount mushroomed to $64,459. Clearly, Citi is shielding these debt
instruments from fair value accounting and the reporting of additional
losses. Footnote 16 indicates that these losses for 2008 amounted to
$(4,082).

Another item concerns the firm’s deferred income
tax assets. For 2008, Citi discloses $52,079 in deferred income tax assets
and a valuation allowance of zero. Given that Citi paid no federal income
taxes in 2007 or 2008 and likely will pay no federal income taxes in the
near future, if ever, how can the company justify a valuation allowance of
zero? Whatever amount it should be would further reduce the profits of the
firm. Since we don’t know how to estimate this valuation allowance
correctly, we shall continue to hold its balance at zero, even though this
is clearly wrong.

Putting these considerations together, Citigroup
has an adjusted income in 2008 of $(53,671). This is still an estimate but
clearly it is more nearly accurate than the reported number. And it reveals
that Citi lost twice as much as it reported.

Recently, we have been hearing how Citi has turned
things around and that the first quarter in 2009 returns Citi to the black
column with a profit of $1,593. Don’t believe a word of it!

Items in comprehensive income shows a modest gain
in the available-for-sale portfolio of $20, gains on cash flow hedges of
$1,483, and a gain because of the pension liability adjustment of $66.
Unfortunately, these gains are wiped out by a loss in the foreign currency
translation adjustment of $(2,974). Comprehensive remains ugly at $(225).

We don’t have any disclosure in the quarterly
report about actual versus expected returns on pension assets, so we cannot
adjust them to show the truth.

But, the strategy to move debt securities from
available-to-sale to held-to-maturity paid off significantly. First quarter
results show a staggering loss on these securities of $(7,772).

So far, the adjusted earnings for Citigroup for the
first quarter of 2009 is $(7,584). Don’t tell me that Citi has improved its
operations.

Further, these numbers have been improved by an
eccentricity in FAS 157. For some silly reason, the board allows entities to
show a gain on their liabilities if the firm’s own credit risk has
increased. This takes a perfectly good notion of fair value of liabilities
to an absurd result. Failing companies might be able to make liabilities
disappear by claiming a sufficiently high increase in their own credit
ratings! Utter rubbish—and the FASB should amend its statement.

Citi disclosed in a conference call that the first
quarter results include a gain of $2,700 because of this increase in its own
nonperformance risk. This gain is total nonsense, so I would adjust
quarterly income further, giving Citi adjusted earnings of $(10,284).

Citigroup suffered a cardiac arrest in 2008, and it
remains in critical condition. Any other conclusion is propaganda or self
deception. And forget the stress tests; they are so flawed that Lehman
Brothers might pass them. The Fed says that Citi needs another $5,500 in
capital to weather any additional economic crises it might face. It isn’t
true. Citi needs a lot more capital than that just to weather current
conditions. If a real crisis occurs, Citi will become a flat-liner; it might
die anyway.

If you want to protect your portfolio, don’t listen
to the optimistic forecasts coming from Washington and don’t stop at the
reported income number. Look at the fair value disclosures within SEC
filings, adjust reported earnings for these fair value gains and losses, and
then you will obtain the truth.

Poor government workers who sacrifice so much just to serve President
Obama:
Biding time before their book royalties eventually flowLawrence Summers, a top economic adviser to President
Barack Obama, pulled in more than $2.7 million in speaking fees paid by firms at
the heart of the financial crisis, including Citigroup, Goldman Sachs, JPMorgan,
Merrill Lynch, Bank of America Corp. and the now-defunct Lehman Brothers. He
pulled in another $5.2 million from D.E. Shaw, a hedge fund for which he served
as managing director from October 2006 until joining the administration. Thomas
E. Donilon, Obama’s deputy national security adviser, was paid $3.9 million by
the power law firm O’Melveny & Myers to represent clients including two firms
that received federal bailout funds: Citigroup and Goldman Sachs. He also
disclosed that he’s a member of the Trilateral Commission and sits on the
steering committee of the supersecret Bilderberg group. Both groups are favorite
targets of conspiracy theorists. And White House Counsel Greg Craig earned $1.7
million in private practice representing an exiled Bolivian president, a
Panamanian lawmaker wanted by the U.S. government for allegedly murdering a U.S.
soldier and a tech billionaire accused of securities fraud and various
sensational drug and sex crimes. Those are among the associations detailed in
personal financial disclosure statements released Friday night by the White
House. Kenneth P. Vogel, "W.H. team
discloses TARP firm ties," Politico, April 3, 2009 ---
http://www.politico.com/news/stories/0409/20889.html

THE fundamental causes
of this recession, unique in the experience of the United States, were
mortgage defaults and the consequent insolvency of major financial firms.
These insolvencies, and especially fear of them, damaged normal credit
mechanisms.

The self-correcting nature of markets will
ultimately prevail. We should not underestimate the power of monetary
policy; with the sharp increase in the nation’s money stock starting in
September, monetary policy is now extraordinarily expansionary. I believe,
though without great confidence, that the recession will end in the second
half of this year.

Federal policy is damaging the economy’s
prospects.
It fails to provide the needed tax incentives for investment in factories
and equipment, incentives that were central to efforts to revive the economy
during the Kennedy-Johnson era and under Ronald Reagan. But government
spending can’t lead the way to sustained recovery, because its stimulating
effect will be offset by anticipated higher taxes and the need to finance
the deficit.

Heavy-handed federal intervention into the
management of companies from banks to auto makers will also delay recovery.
And misguided efforts to help distressed homeowners by permitting courts to
rewrite the terms of mortgages will cause banks to limit mortgage lending,
which will prevent housing from contributing to the recovery.

The unrelenting anger across the country
over bailouts of corporations and households that made unwise and even
irresponsible financial decisions is influencing federal policy. Punitive
measures, like forcing companies receiving federal dollars to cancel
employee events, will increase uncertainty over where the government will
strike next in its effort to deflect public outrage. Instead of more
bailouts, we need a clear and consistent path to fundamental reform of our
financial system.

William Poole is a senior fellow at the Cato Institute and the
president and chief executive of the Federal Reserve Bank of St. Louis from
1998 to 2008.

A democracy cannot exist as a permanent form of
government. It can only exist until the voters discover that they can vote
themselves largesse from the public treasury. From that moment on, the majority
always votes for the candidates promising the most benefits from the public
treasury, with the result that a democracy always collapses over loose fiscal
policy, always followed by a dictatorship.Alexander Tyler. 1787 - Tyler was a Scottish history professor that had
this to say about 2000 years after "The Fall of the Athenian Republic" and about
the time our original 13 states adopted their new constitution.
As quoted at
http://www.babylontoday.com/national_debt_clock.htm (where the debt clock in
real time is a few months behind)The National Debt Amount This Instant (Refresh your browser for
updates by the second) ---
http://www.brillig.com/debt_clock/

America, what is happening to you?“One thing seems probable to me,” said Peer Steinbrück,
the German finance minister, in September 2008....“the United States will lose
its status as the superpower of the global financial system.” You don’t have to
strain too hard to see the financial crisis as the death knell for a
debt-ridden, overconsuming, and underproducing American empire . . . Richard Florida, "How the Crash Will
Reshape America," The Atlantic, March 2009 ---
http://www.theatlantic.com/doc/200903/meltdown-geography

The inherent vice of capitalism is the unequal sharing of the blessings. The
inherent blessing of socialism is the equal sharing of misery.Winston Churchill

(Good thing Obama sent Churchill's bust back to the U.K. from the Oval Office
and replaced it with a bust of Lincoln who wrote that Government should print
all the money it needs without borrowing)

A democracy cannot exist as a permanent form of
government. It can only exist until the voters discover that they can vote
themselves largesse from the public treasury. From that moment on, the majority
always votes for the candidates promising the most benefits from the public
treasury, with the result that a democracy always collapses over loose fiscal
policy, always followed by a dictatorship.Alexander Tyler. 1787 - Tyler was a Scottish history professor that had
this to say about 2000 years after "The Fall of the Athenian Republic" and about
the time our original 13 states adopted their new constitution.
As quoted at
http://www.babylontoday.com/national_debt_clock.htm (where the debt clock in
real time is a few months behind)The National Debt Amount This Instant (Refresh your browser for
updates by the second) ---
http://www.brillig.com/debt_clock/

America, what is happening to you?“One thing seems probable to me,” said Peer Steinbrück,
the German finance minister, in September 2008....“the United States will lose
its status as the superpower of the global financial system.” You don’t have to
strain too hard to see the financial crisis as the death knell for a
debt-ridden, overconsuming, and underproducing American empire . . . Richard Florida, "How the Crash Will
Reshape America," The Atlantic, March 2009 ---
http://www.theatlantic.com/doc/200903/meltdown-geography

America Bought a Pig in a Poke
It's like going on a spending binge
at the Titanic's passenger store just after hitting the icebergAlas, that opportunity was squandered. Mr Obama
ceded control of the stimulus to the fractious congressional Democrats, allowing
a plan that should have had broad support from both parties to become a divisive
partisan battle. More serious still was Mr Geithner’s financial-rescue blueprint
which, though touted as a bold departure from the incrementalism and uncertainty
that had plagued the Bush administration’s Wall Street fixes, in fact looked
depressingly like his predecessors’ efforts: timid, incomplete and short on
detail. Despite talk of trillion-dollar sums, stock markets tumbled. Far from
boosting confidence, Mr Obama seems at sea.
. . . Mr Obama’s team must recognise this or they, like their predecessors, will
come to be seen as part of the problem, not the solution. "The Obama Rescue," The Economist, February 14, 2008, Page
13 ---
http://www.economist.com/opinion/displaystory.cfm?story_id=13108724&CFID=45050187&CFTOKEN=28690481

Barack Obama promised to get the economy's mojo working
again with the passage of an almost $800 billion stimulus package. Wall Street
responded with a Bronx Cheer and a 300 drop in the Dow Jones Industrial Average.
What gives? . . . It is unclear how many more boondoggles will be uncovered in
the 1000+ page bill. People are still pouring through its mass of pages. Few, if
any, members of Congress read the bill before it was passed. Scare tactics well
known to every salesman were used to facilitate its passage. The President
proclaimed the sky was falling. An economic catastrophe was just around the
corner. Congress had to do "something" immediately to forestall disaster. There
was no time to read the fine print or to deliberate in a thoughtful manner. And
in lemming like fashion, the Democrats poured over the cliff. It was their
prerogative they claimed. After all, as Mr. Obama declared, "We won the
election."Ken Connor, "Pork and Pitchforks ,"
Townhall, February 22, 2009 ---
http://townhall.com/columnists/KenConnor/2009/02/22/pork_and_pitchforks

IOUSA (the most frightening movie in American history) --- (see a 30-minute version of the documentary at
www.iousathemovie.com
).
A Must Read for All Americans --- The Fact Accountant That Liberals
Progressives Will Never Interview or Even Discuss
The most important article for the world to read now is the following interview
with a former Andersen Partner and former Chief Accountant of the United States:"Debt Crusader David Walker sounds the alarm for America's financial
future," Journal of Accountancy, March 2009 ---
http://www.journalofaccountancy.com/Issues/2009/Mar/DebtCrusader.htm

David Walker is a man on a mission. As
U.S. comptroller general, he used the bully pulpit to fuel a campaign of
town hall meetings highlighting the country’s ballooning federal deficit.
The Fiscal Wake-Up Tour and the publicity it generated begat the documentary
I.O.U.S.A. Walker hopes the film will do for fiscal irresponsibility what Al
Gore’s An Inconvenient Truth did for global warming—mobilize new citizen
activists and pressure politicians to act.

A year ago, Walker stepped away from the
five-plus remaining years on his term as comptroller general and head of the
Government Accountability Office. He had been recruited by billionaire Pete
Peterson, a co-founder of the private- equity fund The Blackstone Group, to
become president and CEO of Peterson’s foundation. The Peter G. Peterson
Foundation, a nonprofit to which Peterson has pledged $1 billion, focuses on
issues such as the deficit, savings levels, entitlement benefits, health
care costs, and the nation’s tax system.

Walker talked with the JofA recently about
the deficit and the financial crisis. What follow are excerpts from that
conversation.

JofA: What did you hope to
accomplish when you set out on your speaking tour and got involved with the
documentary I.O.U.S.A., and what progress has been made on those goals?

Walker: I have been to over 42 states,
giving speeches, participating in town hall meetings, meeting with business
community leaders, local television and radio stations, and editorial boards
with the objective of trying to state the facts and speak the truth about
the deteriorating financial condition of the United States government and
the need for us to start making some tough choices on budget controls, tax
policy, entitlement reform and spending constraints. And the good news is
that people get it. The American people are a lot smarter than many people
give them credit for—especially elected officials

Well, a lot has happened since we started
the Fiscal Wake-Up Tour. Two significant events would be the 60 Minutes
piece, which ran twice in 2007, and that led to the commercial documentary
I.O.U.S.A. (see a 30-minute version of the documentary at
www.iousathemovie.com
). So there’s a lot more visibility on our issue, and I think that’s
encouraging. The other thing that has happened is the recent market meltdown
and bailouts of some very venerable institutions in the financial services
industry have served to bring things home to America. The concept of “too
big to fail” is just not reality anymore, and when you take on too much debt
and you don’t have adequate cash flow, some very bad things can happen.

Here’s the key. The factors that led to
the mortgage-based subprime crisis exist for the federal government’s
finances. Therefore, we must take steps to avoid a super subprime crisis,
which frankly would have much more disastrous effects not only domestically
but around the world.

JofA:
How does the economic crisis affect your message and the outlook for the
kind of wide-scale changes you think need to be made?

Walker:
What’s critical is that we take advantage of the teachable moment associated
with the market meltdown and the failure of some of the most prominent
financial institutions in the country to help the American people know that
nobody can live beyond his means forever. And that goes for government, too.

We have a new president, and therefore we
have an opportunity to press the reset button, and I hope President Obama
will do two things: That he will assure Americans that he will do what it
takes to turn the economy around. I think it is critically important that he
also focus on the future and be able to put a mechanism in place like a
fiscal future commission so that once we turn the corner on the economy, we
have a set of recommendations Congress and the president would be able to
consider about budget controls, tax reform, entitlement reform—things that
are clear and compelling that we need to act on.

Individuals need to understand that the
government has overpromised and under-delivered for far too long. It is
going to have to engage in some dramatic and fundamental reform of existing
entitlement programs, spending policies and tax policies. The government
will be there to provide a safety net through Social Security, a foundation
of retirement security, and it will be there to help those that are in need.
In general, most individuals are going to have to assume more responsibility
for their own financial future, and the earlier they understand that the
better off they are going to be. They need to have a financial plan, a
budget, make prudent use of debt, save, invest their savings for specified
purposes and, very importantly, preserve their savings for the intended
purpose, including retirement income.

I believe the government policies are
going to have to encourage people to work longer by increasing the
eligibility ages for many government programs. So if people want to retire
at an earlier age, they are going to have to plan, save, invest and preserve
those savings for retirement purposes.

JofA:
You’ve called the current U.S. health care system unsustainable. How can the
system be fixed without negatively affecting the care Americans need?

Walker:
Our current health care system is not really a system. It’s an amalgamation
of a bunch of different things that have occurred over the years, and it’s
unacceptable and unsustainable. We spend twice per capita what any other
country on the Earth does. We have the highest uninsured population of any
industrialized nation. We have below average health care outcomes. So the
value of the equation just does not compute.

We are going to need to do two things on
health care. We are going to need to take some steps quickly to reduce the
rate of increase in health care cost. We are also going to have to better
target taxpayer subsidies and tax preferences for health care.

We are also going to end up needing to
move toward trying to achieve comprehensive health care reform that
accomplishes four key goals. First: achieve universal coverage for basic and
essential health care—based on broad-based societal needs, not unlimited
individual wants—that’s affordable and sustainable over time and that avoids
taxpayer-funded heroic measures. Secondly, the federal government has to
have a budget for health care. We are the only nation on Earth dumb enough
to write a blank check for health care. It could bankrupt the country. We
have to have constraints. Thirdly, we need national evidence-based practice
standards for the practice of medicine and for the issuance of prescription
drugs to improve consistency, enhance quality, reduce costs and dramatically
reduce litigation risks. And last, but certainly not least, we have to
require personal responsibility and accountability for our own health and
wellness in a whole range of areas including obesity.

JofA:
What drives you?

Walker: My family has been in this country
since the 1680s, and I have ancestors who fought and died in the American
Revolution. So I care very deeply about this country, and I am a big history
buff. I believe you need to study history in order to learn from it in order
not to make some of the same mistakes that others have made in the past.

Secondly, I am only the second person in
my direct Walker line to graduate from college. My dad was the first.
Therefore, I am somewhat of an example of what someone can accomplish in
this great country if you get an education, if you have a positive attitude,
if you work hard, if you have good morals and ethical values.

My personal mission in life is to be able
to make a difference, to try and make a difference in the lives of others,
to try and help make sure our country stays strong, that the American dream
stays alive, and that the future will be better for my children and my
grandchildren.

Links to David Walkers videos, including his famous CBS
Sixty Minutes bell ringer that is far more frightening and sobering than
anything Rush Limbaugh is screaming about. You never, ever hear Keith
Olbermann, Jon Stewart, Barack Obama, Nancy Pelosi, or Harry Reid so much as
whisper the name of David Walker ---
http://www.trinity.edu/rjensen/entitlements.htm

A president's most valuable asset—with voters,
Congress, allies and enemies—is credibility. So it is unfortunate when
extreme exaggeration emanates from the White House.

All presidents wind up saying some things that make
even their own economists cringe (often the brainchild of political advisers
unconstrained by economic principles, facts or arithmetic). Usually,
economic advisers manage to correct these problematic statements before
delivery. Sometimes they get channeled into relatively harmless nonsense,
such as President Gerald Ford's "Whip Inflation Now" buttons. Other times
they produce damaging policies, such as President Richard Nixon's wage and
price controls. The most illiterate statement was President Jimmy Carter's
late-1970s plea to the Federal Reserve to lower interest rates to combat
high inflation, the exact opposite of what it should do. Not surprisingly,
the value of the dollar collapsed.

President Obama says "every economist who's looked
at it says that the Recovery Act has done its job"—i.e., the stimulus bill
has turned the economy around. That's nonsense. Opinions differ widely and
many leading economists believe that its impact has been small. Why? The
expectation of future spending and future tax hikes to pay for the stimulus
and Mr. Obama's vast expansion of government are offsetting the direct
short-run expansionary effect. That is standard in all macroeconomic
theories.

So, as I and others warned in 2008, the permanent
government expansion and higher tax rate agenda is a classic example of what
not to do during bad economic times. Worse yet, all the subsidies, bailouts,
regulations and mandates are forcing noncommercial decisions on the economy,
which now awaits literally thousands of new diktats as a result of things
like ObamaCare and the financial reform bill. The uncertainty is impeding
investment and hiring.

The president does not say that economists agree
that the high future taxes to finance the stimulus will hurt the economy.
(The University of Chicago's Harald Uhlig estimates $3.40 of lost output for
every dollar of government spending.) Either the president is not being told
of serious alternative viewpoints, or serious viewpoints are defined as only
those that support his position. In either case, he is being ill-served by
his staff.

Mr. Obama's economic statements are increasingly
divorced not only from competing viewpoints but from those of his own
economic advisers. It is surprising how many numerically challenged
pronouncements come from this most scripted and political of White Houses.
One slip is eventually forgiven, but when a pattern emerges, no one believes
it is an accident.

For example, on the anniversary of the stimulus
bill, Mr. Obama declared, "It is largely thanks to the Recovery Act that a
second Depression is no longer a possibility." Yet his Council of Economic
Advisers just estimated the stimulus bill's effect on GDP at its trough was
1%-2%.

The most common definition of a depression is a
long period in which GDP or consumption declines at least 10%. The decline
in GDP in the recent recession was 3.8%, in consumption 2%. No one disputes
the recession was severe, but to reach a 10% GDP decline requires tripling
the administration's estimate (three times their 2% effect) added to the
actual 3.8% decline. On the alternative consumption standard, the math is
even more absurd. The depression statement isn't credible. The stimulus bill
has assumed certain mystic powers in administration discourse, but revoking
the laws of arithmetic shouldn't be one of them.

The recession would have been worse if not for the
Fed's monetary policy and quantitative easing. Also important were the
unmentioned automatic stabilizers—taxes falling more than income, cushioning
declines in after-tax incomes and consumption—which were far larger than the
spending and tax rebates in the stimulus bill. Arguing that all these
policies (including injecting capital into banks, which was necessary but
done poorly) may have prevented a depression is perhaps still an
exaggeration but at least is within hailing distance of plausibility. On
that scale, the effect of the stimulus was puny.

On his recent "Recovery Tour," Mr. Obama boasted,
"The stimulus bill prevented the unemployment rate from "getting up to . . .
15%." But the president's own chief economic adviser, Christina Romer, has
estimated that the stimulus bill reduced peak unemployment by one percentage
point—i.e., since the unemployment rate peaked at 10.1%, it prevented the
unemployment rate from rising to just over 11%. So Mr. Obama claims that the
stimulus bill was several times more potent than his chief economic adviser
estimates.

Perhaps the most serious disconnect concerns the
impending expiration of the 2001 and 2003 tax cuts, which will raise the top
two income tax rates and the rates on dividends and capital gains. If these
growth inhibiting tax increases occur—about $75 billion in tax increases
next year, $1.4 trillion over 10 years—there will be serious economic
damage.

In the most recent issue of the American Economic
Review, Ms. Romer (and her husband David H. Romer) conclude that "tax
increases are highly contractionary . . . tax cuts have very large and
persistent positive output effects." Their estimates imply the tax increases
would depress GDP by roughly half the growth rate in this so-far-anemic
recovery.

If Mr. Obama is really serious about a second
stimulus, by far the best thing he can do is have Congress quickly extend
the expiring Bush tax cuts, combined with real spending cuts set to take
effect as the economy improves.

The president badly needs to make more realistic
pronouncements. No one expects him to say his policies have failed (although
most have delivered far less than claimed at large cost). A little candor
about the results of experimentation in uncharted waters would go a long
way. But at the very least, his staff needs to avoid putting these
exaggerations on the teleprompter. It undermines confidence and raises
concerns about competence. It's doing nobody any good—not the economy and
certainly not Mr. Obama.

Mr. Boskin is a professor of economics at Stanford University and a
senior fellow at the Hoover Institution. He chaired the Council of Economic
Advisers under President George H.W. Bush.

Harvard professor says economists are a huge part of the problem ---
http://www.trinity.edu/rjensen/2008Bailout.htm#LiquidityBubbleStephen A. Marglin is a professor of economics at Harvard
University. His latest book isThe Dismal Science: How Thinking Like an
Economist Undermines Community(Harvard University Press, 2007).

Question
Why do markets misbehave? How should you measure market risk? And what’s wrong
with academic finance?

These are a few questions that polymath Benoit
Mandelbrot addresses in the fascinating book The Misbehavior of Markets.
Mandelbrot suggests all of these questions can be properly understood by
rejecting the standard assumptions of academic finance and instead using a
“fractal view” of risk and markets.
"The Misbehavior of Markets," Simoleon Sense, April 6, 2009 ---
http://www.simoleonsense.com/

Fractals are at the heart of this book. Fractal
geometry is a form of mathematics developed by Mandelbrot that deals with
rough but highly self-similar structures like trees, coastlines, and
mountains. Fractals have helped explain a wide range of natural phenomena
and revolutionized computer graphics, influencing movies like Star Wars
Episode III. There is room for more applications in this early science, and
fractals may help explain the jagged but predictably irrational patterns in
the stock market, claims Mandelbrot.

In this book, Mandelbrot contends that fractals are
the key to modeling the market. The interesting part is that Mandelbrot does
not merely explain why he’s right but he goes to great length to explain why
others-those using the standard theories of academic finance-are wrong.
Mandelbrot offers interesting history, anecdotes, trivia, and beautiful
illustrations to make his case. The stock market does not act like a random
walk, he says, but rather it’s like the flight of an arrow down an infinite
hallway. It sounds a bit abstract at first, but this is exactly where the
book shines. There are stories and illustrations that make such abstract
concepts easily understandable. I literally felt smarter after reading each
chapter…

Winning the Lotto jackpot has become a key factor in
my retirement plan.New Yorker Cartoon

PEOPLE love to mock the middle class. Its
narrow-mindedness, complacency and conformism are the mother lode of
material for sitcom writers and novelists. But Marx thought “the
bourgeoisie…has played a most revolutionary part” in history. And although
The Economist rarely sees eye to eye with the father of communism,on this Marx was right.

During the past 15 years a new middle
class has sprung up in emerging markets, producing a silent revolution in
human affairs—a revolution of wealth-creation and new aspirations. The
change has been silent because its beneficiaries have gone about
transforming countries unobtrusively while enjoying the fruits of success.
But that success has been a product of growth. As growth collapses, the way
the new middle class reacts to the thwarting of its expectations could
change history in a direction that is still impossible to foresee.

The new middle consists of people with
about a third of their income left for discretionary spending after
providing basic food and shelter. They are neither rich, inheriting enough
to escape the struggle for existence, nor poor, living from hand to mouth,
or season to season. One of their most important characteristics is variety:
middle-class people vary hugely by background, profession and income. As our
special report in this week’s issue argues, their numbers do not grow
gently, shadowing economic growth and rising 2%, or 5%, or 10% a year. At
some point, they surge. That happened in China about ten years ago. It is
happening in India now. In emerging markets as a whole, it has propelled the
middle class from a third of the developing world’s population in 1990 to
over half today. The developing world is no longer simply poor.

As people emerge into the middle class,
they do not merely create a new market. They think and behave differently.
They are more open-minded, more concerned about their children’s future,
more influenced by abstract values than traditional mores. In the words of
David Riesman, an American sociologist, their minds work like radar, taking
in signals from near and far, not like a gyroscope, pivoting on a point.
Ideologically they lean towards free markets and democracy, which tend to be
better than other systems at balancing out varied and conflicting interests.
A poll we commissioned for our special report on the middle class in the
developing world finds that such people are happier, more optimistic and
more supportive of democracy than are the poor.

These attitudes transform countries and
economies. The middle class is more likely to invest in new products and new
technologies than the rich, who tend to defend their existing assets. It is
better able than the poor to leap barriers to entry into business and can
therefore set up companies big enough to generate jobs. With its aspirations
and capacity for delayed gratification, the middle class is more likely to
invest in education and other sources of human capital, which are vital to
prosperity. For years, policymakers have tied economic success to the rich
(“trickle-down economics”) and to the poor (“inclusive growth”). But it is
the middle class that is the real motor of economic growth.

Now the middle class everywhere is under a
great threat. Its members have flourished in places and countries that have
opened up to the world economy—the eastern seaboard of China, southern
India, metropolitan Brazil. They are products of globalisation, and as
globalisation goes into reverse they may well be hit harder than the rich or
poor. They work in export industries, so their jobs are unsafe. They have
started to borrow, so are hurt by the credit crunch. They have houses and
shares, so their wealth is diminished by falling asset prices.

What will they do when the music stops?
Those at the bottom of the ladder do not have far to fall. But what happens
if you have clambered up a few rungs, joined the new middle class and now
face the prospect of slipping back into poverty? History suggests
middle-class people can behave in radically different ways. The rising
middle class of 19th-century Britain agitated peacefully for the vote; in
Latin America in the 1990s the same sorts of people backed democracy. Yet
the middle class also supported fascist governments in Europe in the 1930s
and initially backed military juntas in Latin America in the 1980s.

Nobody can be sure what direction today’s
new bourgeoisie of some 2.5 billion people will take if its aspirations are
dashed. If the downturn lasts only a year or two the attitudes of such
people may survive the pain of retrenchment. But a prolonged crash might
well undo much of the progress the developing world has lately made towards
democracy and political stability. It is hard to imagine the stakes being
higher.

Question: What's $2+$3,269,999,999,998?
Accountant What would you like it to total? We strive to keep our
clients happy.
Politician: I voted for $789,000,000 but I've never been real good with big
numbers having lots of commas.
Economist: Why it's 33 Yen in terms of the anticpated foreign exchange rate ten
years from now.
Congressional Budget Office: $3,270,000,000,000 --- but please don't tell on us

All of the major news outlets are reporting that
the stimulus bill voted out of conference committee last night has a meager $789
billion price tag. This number is pure fantasy. No one believes that the
increased funding for programs the left loves like Head Start, Medicaid, COBRA,
and the Earned Income Tax Credit is in anyway temporary. No Congress under
control of the left will ever cut funding for these programs. So what is the
true cost of the stimulus if these spending increases are made permanent? Rep.
Paul Ryan (R-WI) asked the Congressional Budget Office to estimate the impact of
permanently extending the 20 most popular provisions of the stimulus bill. What
did the CBO find? As you can see from the table below, the true 10 year cost of
the stimulus bill $2.527 trillion in in spending with another $744 billion cost
in debt servicing. Total bill for the Generational Theft Act: $3.27 trillion.
"True Cost of Stimulus: $3.27 Trillion," Heritage Foundation, February 12,
2009 ---
http://blog.heritage.org/2009/02/12/true-cost-of-stimulus-327-trillion/
Jensen Comment
The above article has a pretty good summary table --- the best that I've seen to
date.

The US government is on a “burning platform” of
unsustainable policies and practices with fiscal deficits, chronic healthcare
underfunding, immigration and overseas military commitments threatening a crisis
if action is not taken soon.David M. Walker, Former Chief
Accountant of the United States ---
http://www.financialsense.com/editorials/quinn/2009/0218.html
Also see his dire warnings on CBS Sixty Minutes on the unbooked national debt
for entitlements (over five times the booked national debt and soaring with new
entitlements) ---
http://www.trinity.edu/rjensen/entitlements.htm

Abstract:
The economics profession appears to have been unaware of the long build-up
to the current worldwide financial crisis and to have significantly
underestimated its dimensions once it started to unfold. In our view, this
lack of understanding is due to a misallocation of research efforts in
economics. We trace the deeper roots of this failure to the profession’s
insistence on constructing models that, by design, disregard the key
elements driving outcomes in real-world markets. The economics profession
has failed in communicating the limitations, weaknesses, and even dangers of
its preferred models to the public. This state of affairs makes clear the
need for a major reorientation of focus in the research economists
undertake, as well as for the establishment of an ethical code that would
ask economists to understand and communicate the limitations and potential
misuses of their models.

The first major model of systematic risk and
diversification theory was the 1959 Princeton thesis of Harry Markowitz. But the
model was totally impractical since we could not and still cannot
invert matrices with 500 or more rows and columns. Along came Bill Sharpe
and others who tried to approximate the Markowitz model with the much more
practical CAPM. With simplification a model almost always sacrifices accuracy
and robustness. The CAPM has had some good applications and some disastrous
applications such as the Trillion Dollar Bet disaster of Long Term Capital
Management ---
http://www.trinity.edu/rjensen/2008Bailout.htm#LTCM

Whenever I get news about increased interest in
mathematical models (especially economics and finance) professors on Wall
Street, I think back to "The Trillion Dollar Bet" in 1993 (Nova
on PBS Video) a bond trader, two Nobel Laureates, and their doctoral
students who very nearly brought down all of Wall Street and the U.S. banking
system in the crash of a hedge fund known as
Long Term Capital Management where the biggest and most prestigious firms
lost an unimaginable amount of money ---
http://en.wikipedia.org/wiki/LTCM

The blame for bad decisions that use models must fall on
the analysts who apply the model and not on the people that merely derive the
seminal model as long as the model builders point out all know limitations of
their models. There are some instances of research that should perhaps be banned
such as research that could put cheap and effective biological weapons of mass
destruction in the hands of any teenager in the world who has a basement
laboratory or effective date rape drugs that can be generated quickly, cheaply,
and easily from bananas and tomatoes.

There is also a question of enforcement of a ban on
research and model building. For example, if we’d had a ban on development of
nuclear fission in the U.S., what would’ve prevented Russia, Germany, and Japan
from development of nuclear fission in 1940? If David Li was not allowed to
invent the credit risk diversification model, who’s to say that China could not
invent such a model?

I think the limitations of Li’s model were well known to
the bankers who used the disastrous model. In reality it is like the Black Swan
theory that a model has a known miniscule (epsilon) chance of disaster but the
rewards of using the model seemed to greatly outweigh the risks ---
http://en.wikipedia.org/wiki/Black_Swan_Theory

The CDO bond risks
became compounded when so many investment banks commenced to crumble mortgage
contracts into diversified CDO bonds dictated by David Li’s model. CDO bond
sellers and holders commenced to use this model that essentially leaves out the
covariance terms for interactive defaults on investments. The chances that
everything would blow up seemed negligible at the time. Probably the best
summary of what happens appears in “In Plato’s Cave.”
Also see
"In Plato's Cave: Mathematical models are
a powerful way of predicting financial markets. But they are fallible" The
Economist, January 24, 2009, pp. 10-14 ---
http://www.trinity.edu/rjensen/2008Bailout.htm#Bailout

In one very practical and consequential area,
though, the allure of elegance has exercised a perverse and lasting
influence. For several decades, economists have sought to express the way
millions of people and companies interact in a handful of pretty equations.

The resulting mathematical structures, known as
dynamic stochastic general equilibrium models, seek to reflect our messy
reality without making too much actual contact with it. They assume that
economic trends emerge from the decisions of only a few “representative”
agents -- one for households, one for firms, and so on. The agents are
supposed to plan and act in a rational way, considering the probabilities of
all possible futures and responding in an optimal way to unexpected shocks.

Surreal Models

Surreal as such models might seem, they have played
a significant role in informing policy at the world’s largest central banks.
Unfortunately, they don’t work very well, and they proved spectacularly
incapable of accommodating the way markets and the economy acted before,
during and after the recent crisis.

Now, some economists are beginning to pursue a
rather obvious, but uglier, alternative. Recognizing that an economy
consists of the actions of millions of individuals and firms thinking,
planning and perceiving things differently, they are trying to model all
this messy behavior in considerable detail. Known as agent-based
computational economics, the approach is showing promise.

Take, for example, a 2012 (and still somewhat
preliminary) study by a group of
economists, social scientists, mathematicians and physicists examining the
causes of the housing boom and subsequent collapse from 2000 to 2006.
Starting with data for the Washington D.C. area, the study’s authors built
up a computational model mimicking the behavior of more than two million
potential homeowners over more than a decade. The model included detail on
each individual at the level of race, income, wealth, age and marital
status, and on how these characteristics correlate with home buying
behavior.

Led by further empirical data, the model makes some
simple, yet plausible, assumptions about the way people behave. For example,
homebuyers try to spend about a third of their annual income on housing, and
treat any expected house-price appreciation as income. Within those
constraints, they borrow as much money as lenders’ credit standards allow,
and bid on the highest-value houses they can. Sellers put their houses on
the market at about 10 percent above fair market value, and reduce the price
gradually until they find a buyer.

The model captures things that dynamic stochastic
general equilibrium models do not, such as how rising prices and the
possibility of refinancing entice some people to speculate, buying
more-expensive houses than they otherwise would. The model accurately fits
data on the housing market over the period from 1997 to 2010 (not
surprisingly, as it was designed to do so). More interesting, it can be used
to probe the deeper causes of what happened.

Consider, for example, the assertion of some
prominent economists, such as Stanford University’s
John Taylor, that the
low-interest-rate policies of the Federal Reserve were
to blame for the housing bubble. Some dynamic stochastic general equilibrium
models can be used to support this view. The agent- based model, however,
suggests that interest rates
weren’t the primary driver: If you keep rates at higher levels, the boom and
bust do become smaller, but only marginally.

Leverage Boom

A much more important driver might have been
leverage -- that is, the amount of money a homebuyer could borrow for a
given down payment. In the heady days of the housing boom, people were able
to borrow as much as 100 percent of the value of a house -- a form of easy
credit that had a big effect on housing demand. In the model, freezing
leverage at historically normal levels completely eliminates both the
housing boom and the subsequent bust.

Does this mean leverage was the culprit behind the
subprime debacle and the related global financial crisis? Not necessarily.
The model is only a start and might turn out to be wrong in important ways.
That said, it makes the most convincing case to date (see my blog for more
detail), and it seems likely that any stronger case will have to be based on
an even deeper plunge into the messy details of how people behaved. It will
entail more data, more agents, more computation and less elegance.

If economists jettisoned elegance and got to work
developing more realistic models, we might gain a better understanding of
how crises happen, and learn how to anticipate similarly unstable episodes
in the future. The theories won’t be pretty, and probably won’t show off any
clever mathematics. But we ought to prefer ugly realism to beautiful
fantasy.

(Mark Buchanan, a theoretical physicist and the author of “The Social
Atom: Why the Rich Get Richer, Cheaters Get Caught and Your Neighbor Usually
Looks Like You,” is a Bloomberg View columnist. The opinions expressed are
his own.)

Jensen Comment
Bob Jensen's threads on the mathematical formula that probably led to the
economic collapse after mortgage lenders peddled all those poisoned mortgages
---

"For five years, Li's formula, known as a
Gaussian copula function, looked like an unambiguously positive
breakthrough, a piece of financial technology that allowed hugely
complex risks to be modeled with more ease and accuracy than ever
before. With his brilliant spark of mathematical legerdemain, Li made it
possible for traders to sell vast quantities of new securities,
expanding financial markets to unimaginable levels.

His method was adopted by everybody from bond
investors and Wall Street banks to ratings agencies and regulators. And
it became so deeply entrenched—and was making people so much money—that
warnings about its limitations were largely ignored.

Then the model fell apart." The article goes on to show that correlations
are at the heart of the problem.

"The reason that ratings agencies and investors
felt so safe with the triple-A tranches was that they believed there was
no way hundreds of homeowners would all default on their loans at the
same time. One person might lose his job, another might fall ill. But
those are individual calamities that don't affect the mortgage pool much
as a whole: Everybody else is still making their payments on time.

But not all calamities are individual, and
tranching still hadn't solved all the problems of mortgage-pool risk.
Some things, like falling house prices, affect a large number of people
at once. If home values in your neighborhood decline and you lose some
of your equity, there's a good chance your neighbors will lose theirs as
well. If, as a result, you default on your mortgage, there's a higher
probability they will default, too. That's called correlation—the degree
to which one variable moves in line with another—and measuring it is an
important part of determining how risky mortgage bonds are."

I would highly recommend reading the entire thing that gets much more
involved with the
actual formula etc.

The
“math error” might truly be have been an error or it might have simply been a
gamble with what was perceived as miniscule odds of total market failure.
Something similar happened in the case of the trillion-dollar disastrous 1993
collapse of Long Term Capital Management formed by Nobel Prize winning
economists and their doctoral students who took similar gambles that ignored the
“miniscule odds” of world market collapse -- -
http://www.trinity.edu/rjensen/FraudRotten.htm#LTCM

The
rhetorical question is whether the failure is ignorance in model building or
risk taking using the model?

Wall Street’s Math Wizards Forgot a Few VariablesWhat wasn’t recognized was the importance of a
different species of risk — liquidity risk,” Stephen Figlewski, a professor of
finance at the Leonard N. Stern School of Business at New York University, told
The Times. “When trust in counterparties is lost, and markets freeze up so there
are no prices,” he said, it “really showed how different the real world was from
our models.
DealBook, The New York Times, September 14, 2009 ---
http://dealbook.blogs.nytimes.com/2009/09/14/wall-streets-math-wizards-forgot-a-few-variables/

An Excellent Presentation on the Flaws of Finance, Particularly the Flaws
of Financial Theorists

A recent topic on the AECM listserv concerns the limitations of accounting
standard setters and researchers when it comes to understanding investors. One
point that was not raised in the thread to date is that a lot can be learned
about investors from the top financial analysts of the world --- their writings
and their conferences.

The only group of people who view the world realistically are the
clinically depressed.

Model builders should stop substituting
elegance for reality.

All financial theorists should be forced to
interact with practitioners.

Practitioners need to abandon the myth of optimality before the fact.
Jensen Note
This also applies to abandoning the myth that we can set optimal accounting
standards.

In the long term fundamentals matter.

Don't get too bogged down in details at the expense of the big picture.

Max Plank said science advances one funeral at a time.

The speaker then entertains questions from the audience (some are very
good).

James Montier is a very good speaker from England!

Mr. Montier is a member of GMO’s asset allocation
team. Prior to joining GMO in 2009, he was co-head of Global Strategy at
Société Générale. Mr. Montier is the author of several books including
Behavioural Investing: A Practitioner’s Guide to Applying Behavioural
Finance; Value Investing: Tools and Techniques for Intelligent Investment;
and The Little Book of Behavioural Investing. Mr. Montier is a visiting
fellow at the University of Durham and a fellow of the Royal Society of
Arts. He holds a B.A. in Economics from Portsmouth University and an M.Sc.
in Economics from Warwick University
http://www.gmo.com/america/about/people/_departments/assetallocation.htm

There's a lot of useful information in this talk for accountics scientists.

Math Error on Wall StreetIssuance of CDO portfolio bonds laced with a portion of
healthy mortgages and a portion of poisoned mortgages.
The math error is based on an assumption that risk of poison can be diversified
and diluted using a risk diversification formula.
The risk diversification formula is called the Gaussian copula function
The formula made a fatal assumption that loan defaults would be random events
and not correlated.
When the real estate bubble burst, home values plunged and loan defaults became
correlated and enormous.

Fraud on Wall StreetAll the happenings on Wall Street were not merely innocent
math errorsBanks and investment banks were selling CDO bonds that they knew were
overvalued.
Credit rating agencies knew they were giving AAA high credit ratings to bonds
that would collapse.
The banking industry used powerful friends in government to pass its default
losses on to taxpayers.
Greatest Swindle in the History of the World --- http://www.trinity.edu/rjensen/2008Bailout.htm#Bailout

In one very practical and consequential area,
though, the allure of elegance has exercised a perverse and lasting
influence. For several decades, economists have sought to express the way
millions of people and companies interact in a handful of pretty equations.

The resulting mathematical structures, known as
dynamic stochastic general equilibrium models, seek to reflect our messy
reality without making too much actual contact with it. They assume that
economic trends emerge from the decisions of only a few “representative”
agents -- one for households, one for firms, and so on. The agents are
supposed to plan and act in a rational way, considering the probabilities of
all possible futures and responding in an optimal way to unexpected shocks.

Surreal Models

Surreal as such models might seem, they have played
a significant role in informing policy at the world’s largest central banks.
Unfortunately, they don’t work very well, and they proved spectacularly
incapable of accommodating the way markets and the economy acted before,
during and after the recent crisis.

Now, some economists are beginning to pursue a
rather obvious, but uglier, alternative. Recognizing that an economy
consists of the actions of millions of individuals and firms thinking,
planning and perceiving things differently, they are trying to model all
this messy behavior in considerable detail. Known as agent-based
computational economics, the approach is showing promise.

Take, for example, a 2012 (and still somewhat
preliminary) study by a group of
economists, social scientists, mathematicians and physicists examining the
causes of the housing boom and subsequent collapse from 2000 to 2006.
Starting with data for the Washington D.C. area, the study’s authors built
up a computational model mimicking the behavior of more than two million
potential homeowners over more than a decade. The model included detail on
each individual at the level of race, income, wealth, age and marital
status, and on how these characteristics correlate with home buying
behavior.

Led by further empirical data, the model makes some
simple, yet plausible, assumptions about the way people behave. For example,
homebuyers try to spend about a third of their annual income on housing, and
treat any expected house-price appreciation as income. Within those
constraints, they borrow as much money as lenders’ credit standards allow,
and bid on the highest-value houses they can. Sellers put their houses on
the market at about 10 percent above fair market value, and reduce the price
gradually until they find a buyer.

The model captures things that dynamic stochastic
general equilibrium models do not, such as how rising prices and the
possibility of refinancing entice some people to speculate, buying
more-expensive houses than they otherwise would. The model accurately fits
data on the housing market over the period from 1997 to 2010 (not
surprisingly, as it was designed to do so). More interesting, it can be used
to probe the deeper causes of what happened.

Consider, for example, the assertion of some
prominent economists, such as Stanford University’s
John Taylor, that the
low-interest-rate policies of the Federal Reserve were
to blame for the housing bubble. Some dynamic stochastic general equilibrium
models can be used to support this view. The agent- based model, however,
suggests that interest rates
weren’t the primary driver: If you keep rates at higher levels, the boom and
bust do become smaller, but only marginally.

Leverage Boom

A much more important driver might have been
leverage -- that is, the amount of money a homebuyer could borrow for a
given down payment. In the heady days of the housing boom, people were able
to borrow as much as 100 percent of the value of a house -- a form of easy
credit that had a big effect on housing demand. In the model, freezing
leverage at historically normal levels completely eliminates both the
housing boom and the subsequent bust.

Does this mean leverage was the culprit behind the
subprime debacle and the related global financial crisis? Not necessarily.
The model is only a start and might turn out to be wrong in important ways.
That said, it makes the most convincing case to date (see my blog for more
detail), and it seems likely that any stronger case will have to be based on
an even deeper plunge into the messy details of how people behaved. It will
entail more data, more agents, more computation and less elegance.

If economists jettisoned elegance and got to work
developing more realistic models, we might gain a better understanding of
how crises happen, and learn how to anticipate similarly unstable episodes
in the future. The theories won’t be pretty, and probably won’t show off any
clever mathematics. But we ought to prefer ugly realism to beautiful
fantasy.

(Mark Buchanan, a theoretical physicist and the author of “The Social
Atom: Why the Rich Get Richer, Cheaters Get Caught and Your Neighbor Usually
Looks Like You,” is a Bloomberg View columnist. The opinions expressed are
his own.)

Jensen Comment
Bob Jensen's threads on the mathematical formula that probably led to the
economic collapse after mortgage lenders peddled all those poisoned mortgages
---

"For five years, Li's formula, known as a
Gaussian copula function, looked like an unambiguously positive
breakthrough, a piece of financial technology that allowed hugely
complex risks to be modeled with more ease and accuracy than ever
before. With his brilliant spark of mathematical legerdemain, Li made it
possible for traders to sell vast quantities of new securities,
expanding financial markets to unimaginable levels.

His method was adopted by everybody from bond
investors and Wall Street banks to ratings agencies and regulators. And
it became so deeply entrenched—and was making people so much money—that
warnings about its limitations were largely ignored.

Then the model fell apart." The article goes on to show that correlations
are at the heart of the problem.

"The reason that ratings agencies and investors
felt so safe with the triple-A tranches was that they believed there was
no way hundreds of homeowners would all default on their loans at the
same time. One person might lose his job, another might fall ill. But
those are individual calamities that don't affect the mortgage pool much
as a whole: Everybody else is still making their payments on time.

But not all calamities are individual, and
tranching still hadn't solved all the problems of mortgage-pool risk.
Some things, like falling house prices, affect a large number of people
at once. If home values in your neighborhood decline and you lose some
of your equity, there's a good chance your neighbors will lose theirs as
well. If, as a result, you default on your mortgage, there's a higher
probability they will default, too. That's called correlation—the degree
to which one variable moves in line with another—and measuring it is an
important part of determining how risky mortgage bonds are."

I would highly recommend reading the entire thing that gets much more
involved with the
actual formula etc.

The
“math error” might truly be have been an error or it might have simply been a
gamble with what was perceived as miniscule odds of total market failure.
Something similar happened in the case of the trillion-dollar disastrous 1993
collapse of Long Term Capital Management formed by Nobel Prize winning
economists and their doctoral students who took similar gambles that ignored the
“miniscule odds” of world market collapse -- -
http://www.trinity.edu/rjensen/FraudRotten.htm#LTCM

History
(Long Term
Capital Management and CDO Gaussian Coppola failures)
Repeats Itself in Over a Billion Lost in MF Global

"The entire system has been utterly destroyed by
the MF Global collapse," Ann Barnhardt, founder and CEO of Barnhardt Capital
Management, declared last week in a letter to clients.

Whether that's hyperbole or not is a matter of
opinion, but MF Global's collapse — and the inability of investigators to
find about $1.2 billion in "missing" customer funds, which is twice the
amount previously thought — has only further undermined confidence among
investors and market participants alike.

Emanuel Derman, a professor at Columbia University
and former Goldman Sachs managing director, says MF Global was undone by
an over-reliance on short-term funding, which dried up as revelations of its
leveraged bets on European sovereign debt came to light.

In the accompanying video, Derman says MF Global
was much more like Long Term Capital Management than Goldman Sachs, where he
worked on the risk committee for then-CEO John Corzine.

As discussed in the accompanying video, Derman says
the "idolatry" of financial models puts Wall Street firms — if not the
entire banking system — at risk of catastrophe. MF Global was an extreme
example of what can happen when the models — and the people who run them --
behave badly, but if Barnhardt is even a little bit right, expect more
casualties to emerge.

America Bought a Pig in a Poke: It's like going on a spending binge at
the Titanic's store just after hitting the icebergBarack Obama promised to get the economy's mojo working
again with the passage of an almost $800 billion stimulus package. Wall Street
responded with a Bronx Cheer and a 300 drop in the Dow Jones Industrial Average.
What gives? . . . It is unclear how many more boondoggles will be uncovered in
the 1000+ page bill. People are still pouring through its mass of pages. Few, if
any, members of Congress read the bill before it was passed. Scare tactics well
known to every salesman were used to facilitate its passage. The President
proclaimed the sky was falling. An economic catastrophe was just around the
corner. Congress had to do "something" immediately to forestall disaster. There
was no time to read the fine print or to deliberate in a thoughtful manner. And
in lemming like fashion, the Democrats poured over the cliff. It was their
prerogative they claimed. After all, as Mr. Obama declared, "We won the
election."Ken Connor, "Pork and Pitchforks ,"
Townhall, February 22, 2009 ---
http://townhall.com/columnists/KenConnor/2009/02/22/pork_and_pitchforks

You cannot legislate the poor into freedom by
legislating the wealthy out of freedom. What one person receives without working
for, another person must work for without receiving. The government cannot give
to anybody anything that the government does not first take from somebody else.
When half of the people get the idea that they do not have to work because the
other half is going to take care of them, and when the other half gets the idea
that it does no good to work because somebody else is going to get what they
work for, that my dear friend, is about the end of any nation. You cannot
multiply wealth by dividing it.Ronald
Reagan

America, what is happening to you?“One thing seems probable to me,” said Peer Steinbrück,
the German finance minister, in September 2008....“the United States will lose
its status as the superpower of the global financial system.” You don’t have to
strain too hard to see the financial crisis as the death knell for a
debt-ridden, overconsuming, and underproducing American empire . . . Richard Florida, "How the Crash Will
Reshape America," The Atlantic, March 2009 ---
http://www.theatlantic.com/doc/200903/meltdown-geography

Professor Schiller at Yale asserts housing
prices are still overvalued and need to come down to realityThe median value of a U.S. home in 2000 was $119,600.
It peaked at $221,900 in 2006. Historically, home prices have risen annually in
line with CPI. If they had followed the long-term trend, they would have
increased by 17% to $140,000. Instead, they skyrocketed by 86% due to Alan
Greenspan’s irrational lowering of interest rates to 1%, the criminal pushing of
loans by lowlife mortgage brokers, the greed and hubris of investment bankers
and the foolishness and stupidity of home buyers. It is now 2009 and the median
value should be $150,000 based on historical precedent. The median value at the
end of 2008 was $180,100. Therefore, home prices are still 20% overvalued.
Long-term averages are created by periods of overvaluation followed by periods
of undervaluation. Prices need to fall 20% and could fall 30%.....
Watch the video on Yahoo Finance ---
Click Here
See the chart at
http://www.businessinsider.com/the-housing-chart-thats-worth-1000-words-2009-2
Also see Jim Mahar's blog at
http://financeprofessorblog.blogspot.com/2009/02/shiller-house-prices-still-way-too-high.html
Jensen Comment
In the worldwide move toward fair value accounting that replaces cost allocation
accounting, the above analysis by Professor Schiller is sobering. It suggests
how much policy and widespread fraud can generate misleading "fair values" in
deep markets with many buyers and sellers, although the housing market is a bit
more like the used car market than the stock market. Each house and each used
car are unique, non-fungible items that are many times more difficult to update
with fair value accounting relative to fungible market securities and new car
markets.

The government gave them 105% for their
$200,000 subprime mortgage.
They then sold the house for $37,000, got married, and are escaping from
California.

So are we now that we flipped the doghouse!

It is apparent that we've learned nothing from
several millennia of monetary destruction. The persistent demonstration that
capital, not paper, is the basis for prosperity has fallen on deaf ears. Daily,
we face the sad spectacle of government officials, pundits, and even Nobel
laureates (read that Paul Klugman from the Zimbabwe School of
Finance) telling us that printing money is the answer
to an economic downturn.
"Printing Like Mad," Mises Economic Blog, February 15, 2009 ---
http://blog.mises.org/archives/009457.asp

I started saving up in the barn to buy a new
snow shovel in about six years.

Question
As of December 2008, what do Zimbabwe and the United States have in common?

Answer
Rather than taxing or borrowing to cover deficit spending, both governments are
simply printing more money?

What's wrong with that?
First look at what it did to Zimbabwe. Then read about Gresham's Law ---
http://en.wikipedia.org/wiki/Gresham%27s_Law
The instant the Federal Reserve announced this new funding policy in December,
the U.S. dollar plunged in value relative to foreign currencies. The reason is
obvious.

Zimbabwe's central bank will introduce a 100
trillion Zimbabwe dollar banknote, worth about $33 on the black market, to try
to ease desperate cash shortages, state-run media said on Friday. KyivPost, January 16, 2009 ---
http://www.kyivpost.com/world/33522
Jensen Comment
This is a direct result of raising money by simply printing it, and the U.S.
should take note since this is how our Federal government has decided to pay for
anticipated trillion-dollar budget deficits ---
http://www.trinity.edu/rjensen/2008Bailout.htm#NationalDebt

The United States will "look like a banana republic"
unless it gains control over its budget deficit and federal debt, economist
Allen Sinai warned Congress on Thursday. "The deficit and debt prospects under
almost any scenario are daunting," Mr. Sinai, chief global economist for
Decision Economics Inc., told the Senate Budget Committee. "This territory is
uncharted, with no real historical analogue to this kind of financial situation
for a major global economic power." Asked by committee Chairman Kent Conrad,
North Dakota Democrat, whether the U.S. government's creditworthiness is at
risk, Mr. Sinai replied, "Unequivocally yes." Richard Berner, chief U.S.
economist at Morgan Stanley, told the committee one measure of America's
creditworthiness -- credit default swap spreads -- already shows some
deterioration. The worse a nation's credit rating becomes, the more its CDS
spread rises. U.S. sovereign CDS spreads have widened to about 0.6 percent from
0.1 percent last summer, Mr. Berner noted. "So the message is that you ignore
global investors at your peril," he told the committee.
David M. Dixon, "Congress warned about debt U.S.
advised to gain control," The Washington Times, January 16, 2009 ---
http://washingtontimes.com/news/2009/jan/16/policies-on-debt-a-risk-to-economy/

After Thomas Sargent learned on Monday morning that
he and colleague Christopher Sims had been awarded the Nobel Prize in
Economics for 2011, the 68-year-old New York University professor struck an
aw-shucks tone with an interviewer from the official Nobel website: “We're
just bookish types that look at numbers and try to figure out what's going
on.”

But no one who'd followed Prof. Sargent's long,
distinguished career would have been fooled by his attempt at modesty. He'd
won for his part in developing one of economists' main models of cause and
effect: How can we expect people to respond to changes in prices, for
example, or interest rates? According to the laureates' theories, they'll do
whatever's most beneficial to them, and they'll do it every time. They don't
need governments to instruct them; they figure it out for themselves.
Economists call this the “rational expectations” model. And it's not just an
abstraction: Bankers and policy-makers apply these formulae in the real
world, so bad models lead to bad policy.

Which is perhaps why, by the end of that interview
on Monday, Prof. Sargent was adopting a more realistic tone: “We experiment
with our models,” he explained, “before we wreck the world.”

Rational-expectations theory and its corollary, the
efficient-market hypothesis, have been central to mainstream economics for
more than 40 years. And while they may not have “wrecked the world,” some
critics argue these models have blinded economists to reality: Certain the
universe was unfolding as it should, they failed both to anticipate the
financial crisis of 2008 and to chart an effective path to recovery.

The economic crisis has produced a crisis in the
study of economics – a growing realization that if the field is going to
offer meaningful solutions, greater attention must be paid to what is
happening in university lecture halls and seminar rooms.

While the protesters occupying Wall Street are not
carrying signs denouncing rational-expectations and efficient-market
modelling, perhaps they should be.

They wouldn't be the first young dissenters to call
economics to account. In June of 2000, a small group of elite graduate
students at some of France's most prestigious universities declared war on
the economic establishment. This was an unlikely group of student radicals,
whose degrees could be expected to lead them to lucrative careers in
finance, business or government if they didn't rock the boat. Instead, they
protested – not about tuition or workloads, but that too much of what they
studied bore no relation to what was happening outside the classroom walls.

They launched an online petition demanding greater
realism in economics teaching, less reliance on mathematics “as an end in
itself” and more space for approaches beyond the dominant neoclassical
model, including input from other disciplines, such as psychology, history
and sociology. Their conclusion was that economics had become an “autistic
science,” lost in “imaginary worlds.” They called their movement
Autisme-economie.

The students' timing is notable: It was the spring
of 2000, when the world was still basking in the glow of “the Great
Moderation,” when for most of a decade Western economies had been enjoying a
prolonged period of moderate but fairly steady growth.

Some economists were daring to think the
unthinkable – that their understanding of how advanced capitalist economies
worked had become so sophisticated that they might finally have succeeded in
smoothing out the destructive gyrations of capitalism's boom-and-bust cycle.
(“The central problem of depression prevention has been solved,” declared
another Nobel laureate, Robert Lucas of the University of Chicago, in 2003 –
five years before the greatest economic collapse in more than half a
century.)

The students' petition sparked a lively debate. The
French minister of education established a committee on economic education.
Economics students across Europe and North America began meeting and
circulating petitions of their own, even as defenders of the status quo
denounced the movement as a Trotskyite conspiracy. By September, the first
issue of the Post-Autistic Economic Newsletter was published in Britain.

As The Independent summarized the students'
message: “If there is a daily prayer for the global economy, it should be,
‘Deliver us from abstraction.'”

It seems that entreaty went unheard through most of
the discipline before the economic crisis, not to mention in the offices of
hedge funds and the Stockholm Nobel selection committee. But is it ringing
louder now? And how did economics become so abstract in the first place?

The great classical economists of the late 18th and
early 19th centuries had no problem connecting to the real world – the
Industrial Revolution had unleashed profound social and economic changes,
and they were trying to make sense of what they were seeing. Yet Adam Smith,
who is considered the founding father of modern economics, would have had
trouble understanding the meaning of the word “economist.”

What is today known as economics arose out of two
larger intellectual traditions that have since been largely abandoned. One
is political economy, which is based on the simple idea that economic
outcomes are often determined largely by political factors (as well as vice
versa). But when political-economy courses first started appearing in
Canadian universities in the 1870s, it was still viewed as a small offshoot
of a far more important topic: moral philosophy.

In The Wealth of Nations (1776), Adam Smith
famously argued that the pursuit of enlightened self-interest by individuals
and companies could benefit society as a whole. His notion of the market's
“invisible hand” laid the groundwork for much of modern neoclassical and
neo-liberal, laissez-faire economics. But unlike today's free marketers,
Smith didn't believe that the morality of the market was appropriate for
society at large. Honesty, discipline, thrift and co-operation, not
consumption and unbridled self-interest, were the keys to happiness and
social cohesion. Smith's vision was a capitalist economy in a society
governed by non-capitalist morality.

But by the end of the 19th century, the new field
of economics no longer concerned itself with moral philosophy, and less and
less with political economy. What was coming to dominate was a conviction
that markets could be trusted to produce the most efficient allocation of
scarce resources, that individuals would always seek to maximize their
utility in an economically rational way, and that all of this would
ultimately lead to some kind of overall equilibrium of prices, wages, supply
and demand.

Political economy was less vital because government
intervention disrupted the path to equilibrium and should therefore be
avoided except in exceptional circumstances. And as for morality, economics
would concern itself with the behaviour of rational, self-interested,
utility-maximizing Homo economicus. What he did outside the confines of the
marketplace would be someone else's field of study.

As those notions took hold, a new idea emerged that
would have surprised and probably horrified Adam Smith – that economics,
divorced from the study of morality and politics, could be considered a
science. By the beginning of the 20th century, economists were looking for
theorems and models that could help to explain the universe. One historian
described them as suffering from “physics envy.” Although they were dealing
with the behaviour of humans, not atoms and particles, they came to believe
they could accurately predict the trajectory of human decision-making in the
marketplace.

In their desire to have their field be recognized
as a science, economists increasingly decided to speak the language of
science. From Smith's innovations through John Maynard Keynes's work in the
1930s, economics was argued in words. Now, it would go by the numbers.

In effect, the Fed is stepping in as a
substitute for banks and other lenders and acting more like a bank itself.
“The Federal Reserve will employ all available tools to promote the
resumption of sustainable economic growth,” it said. Those tools include
buying “large quantities” of mortgage-related bonds, longer-term Treasury
bonds, corporate debt and even consumer loans.

The move came as President-elect Barack
Obama summoned his economic team to a four-hour meeting in Chicago to map
out plans for an enormous economic stimulus measure that could cost anywhere
from $600 billion to $1 trillion over the next two years.

The two huge economic stimulus programs,
one from the Fed and one from the White House and Congress, set the stage
for a powerful but potentially risky partnership between Mr. Obama and the
Fed’s Republican chairman, Ben S. Bernanke.

“We are running out of the traditional
ammunition that’s used in a recession, which is to lower interest rates,”
Mr. Obama said at a news conference Tuesday. “It is critical that the other
branches of government step up, and that’s why the economic recovery plan is
so essential.”

Financial markets were electrified by the
Fed action. The Dow Jones industrial average jumped 4.2 percent, or 359.61
points, to close at 8,924.14.

Investors rushed to buy long-term Treasury
bonds. Yields on 10-year Treasuries, which have traditionally served as a
guide for mortgage rates, plunged immediately after the announcement to 2.26
percent, their lowest level in decades, from 2.51 percent earlier in the
day.

Yields on investment-grade corporate bonds
edged down to 7.215 percent on Tuesday, from 7.355 on Monday. Yields on
riskier high-yielding corporate bonds remained in the stratosphere at 22.493
percent, almost unchanged from 22.732 on Monday.

By contrast, the dollar dropped sharply
against the euro and other major currencies for the second consecutive day —
a sign that currency markets were nervous about a flood of newly printed
dollars.
Some analysts predict that the Treasury will have to sell $2 trillion worth
of new securities over the next year to finance its existing budget deficit,
a new stimulus program and to refinance about $600 billion worth of maturing
government debt.

For the moment, Mr. Obama and Mr. Bernanke
appear to be on the same page, though that could abruptly change if the
economy starts to revive. Fed officials have already assumed that Congress
will pass a major spending program to stimulate the economy, and they are
counting on it to contribute to economic growth next year.

In more normal times, the Fed might easily
start raising interest rates in reaction to a huge new spending program, out
of concern about rising inflation.

But data on Tuesday provided new evidence
that the biggest threat to prices right now was not inflation but deflation.

The federal government reported on Tuesday
that the Consumer Price Index fell 1.7 percent in November, the steepest
monthly drop since the government began tracking prices in 1947. The decline
was largely driven by the recent plunge in energy prices, but even the
so-called core inflation rate, which excludes the volatile food and energy
sectors, was essentially zero.

Mr. Obama’s goal is to have a package
ready when the new Congress convenes on Jan. 6. His hope is that the House
and Senate, with their bigger Democratic majorities, can agree quickly on a
plan for Mr. Obama to sign into law soon after he is sworn into office two
weeks later.

The Fed, in a statement accompanying its
rate decision, acknowledged that the recession was more severe than
officials had thought at their last meeting in October.

“Labor market conditions have
deteriorated, and the available data indicate that consumer spending,
business investment and industrial production have declined.”

The central bank added: “The committee
anticipates that weak economic conditions are likely to warrant
exceptionally low levels of the federal funds rate for some time.”

With fewer than 10 days until Christmas,
retailers from Saks Fifth Avenue to Wal-Mart have been slashing prices to
draw in consumers, who have sharply reduced their spending over the last six
months. On Tuesday, Banana Republic offered customers $50 off on any
purchases that total $125. The clothing retailer DKNY offered customers $50
off any purchase totaling $250.

Ian Shepherdson, an analyst at High
Frequency Economics, said falling energy prices were likely to bring the
year-over-year rate of inflation to below zero in January.

The Fed has already announced or outlined
a range of unorthodox new tools that it can use to keep stimulating the
economy once the federal funds rate effectively reaches zero. On Tuesday,
Fed officials said they stood ready to expand them or create new ones to
relieve bottlenecks in the credit markets.

All of the tools involve borrowing by the
Fed, which amounts to printing money in vast new quantities, a process the
Fed has already started.
Since September, the Fed’s balance sheet has ballooned from about $900
billion to more than $2 trillion as it has created money and lent it out. As
soon as the Fed completes its plans to buy mortgage-backed debt and consumer
debt, the balance sheet will be up to about $3 trillion.

“At some point, and without knowing the
timing, the Fed is going to have to destroy all that money it is creating,”
said Alan Blinder, a professor of economics at Princeton and a former vice
chairman of the Federal Reserve.

“Right now, the crisis is created by the
huge demand by banks for hoarding cash. The Fed is providing cash, and the
banks want to hoard it. When things start returning to normal, the banks
will want to start lending it out. If that much money is left in the
monetary base, it would be extremely inflationary.”

This is the thing I’ve been afraid of ever since I
realized that Japan really was in the dreaded, possibly mythical liquidity trap.
You can read my 1998 Brookings Paper on the issuehere.
Incidentally, there were a bunch of us at Princeton
worrying about the Japan problem in the early years of this decade. I was one;
Lars Svensson, currently at Sweden’s Riksbank, was another; a third was a guy
named Ben Bernanke. I wonder whatever happened to him?Paul Krugman, "ZIRP," The New York Times, December 16, 2008
---
http://krugman.blogs.nytimes.com/2008/12/16/zirp/?scp=8&sq=printing money&st=cse

How much to bail out the banks now? $3.5 trillion by one estimate
America, what is happening to you?A federal program to guarantee or buy bad assets from
the ailing U.S. bank sector could come with a $3.5 trillion price tag. That
would push the accumulated costs of rescuing the financial markets over the last
year through various federal loan, stock purchase, debt guarantee and other
programs close to $9 trillion and counting, with practically no end in sight for
the bad news battering the banking industry. That figure doesn't count the $825
billion economic stimulus plan also under consideration. "We expect massive
federal intervention into the financial sector from the new administration in
the coming months," says Keefe Bruyette & Woods analyst Frederick Cannon, who
calculated the $3.5 trillion figure, which is one-quarter of the banking
sector's $14 trillion in combined assets. Liz Moyer, "A TARP In The Trillions?"
Forbes, January 21, 2009 ---
http://www.forbes.com/2009/01/21/tarp-banking-treasury-biz-wall-cx_lm_0121tarp.html
Jensen Comment
The estimate is now almost double the above figure.So how much are we talking about in
the already-existing toxic paper already held by Fannie, Freddie, and the most
poisoned banks?
Estimates place these at $6 trillion, which is well over half our out-of-control
existing National Debt ---
http://online.wsj.com/article/SB123396703401759083.html?mod=djemEditorialPage

Plus another $3,6 trillion maybeAmerica, what is happening to you?
Much has been made of the subprime debacle. But few seem to be willing to talk
about another looming crisis: credit card debt. People like Nouriel Roubini, the
professor who has predicted much of this crisis, have estimated that you could
have losses of as much as $3.6 trillion, which would bankrupt the industry. What
do you make of that number? And since credit card defaults are correlated to
employment, what happens if unemployment goes as high as 10 percent or more?
What is the highest unemployment level that you’ve used in your forecasting
models? And do you have adequate reserves for your worst-case situation? If your
assumptions are wrong, what happens?Andrew Ross Sorkin, "Up Next for
Bankers: A Flogging," The New York Times, February 9, 2009 ---
http://www.nytimes.com/2009/02/10/business/10sorkin.html?_r=1&partner=permalink&exprod=permalink

As it has so often in recent months, the market
elation that greeted the Federal Reserve's epic monetary easing earlier this
week has turned to worry. Stocks fell off again yesterday, but the big news of
the week has been the slide in the dollar. The nearby chart shows the
greenback's story since September. From its dangerous summer lows, the buck
soared at the height of the credit panic as investors looked for safety in a
hurricane. But the dollar has fallen like Newton's apple in December, as
Chairman Ben Bernanke and his comrades signaled that they are willing to cut
interest rates to near-zero and print as much money as it takes to prevent a
deflation.
"A Dollar Referendum Currency markets reflect a lack of faith in Bernanke,"
The Wall Street Journal, December 19, 2008 ---
http://online.wsj.com/article/SB122965017184420567.html

A few quick facts about Wall Street bonuses. The
pretext for the political outrage was the New York comptroller's report this
week on the aggregate data for bonuses in 2008. That "irresponsible" bonus pool
of $18 billion was for every worker in the New York financial industry, from top
dogs to secretaries. This bonus pool fell 44% in 2008, the largest percentage
decline in 30 years. The average bonus was $112,000; bonuses typically make up
most of an employee's salary on Wall Street. The comptroller estimates that this
decline will cost New York State $1 billion in lost tax revenue and New York
City $275 million. Both city and state may have to announce layoffs. "'Idiots' Indeed," The Wall Street Journal, January 31,
2009 ---
http://online.wsj.com/article/SB123336371503735447.html?mod=djemEditorialPage
Jensen Comment
Although this puts our bonus contempt somewhat in a new light, it also does not
lesson opinion that John Thain and the other crooks who declared themselves
multi-million bonuses are one of the reasons that America now despises Wall
Street. Actually Thain wanted a $10 million bonus while captain of his sinking
ship (Merrill Lynch).
Bob Jensen's threads on outrageous executive compensation ---
http://online.wsj.com/article/SB123336371503735447.html?mod=djemEditorialPage

SUMMARY: "Bank of America Corp. agreed to pay $2.43 billion to
settle claims it misled investors about the acquisition of troubled
brokerage firm Merrill Lynch & Co...." during the financial crisis in 2008.
At the time it acquired Merrill Lynch in September 2008, BofA became the
biggest U.S. bank; the value of the bank then fell by more than half by the
time the acquisition of Merrill Lynch closed 3 months later. These losses
were not disclosed by then CEO Ken Lewis and his management team to
shareholders before they voted on the merger transaction with Merrill.

CLASSROOM APPLICATION: The article addresses accounting for
litigation contingent liabilities. The related video clearly discusses the
history of the transactions.

2. (Introductory) For what losses did BofA agree to make this
payment?

3. (Advanced) How could losses have occurred and a payment of $2.4
billion be required if "Bank of America executives now say Merrill...has
become a big profit contributor... [and that] it's clear that Merrill is a
significant positive any way you want to look at it..."?

4. (Advanced) What accounting standards provide the requirements to
account for costs such as this $2.4 billion payment by BofA?

5. (Advanced) According to the article, BofA has "set aside more
than $42 billion in litigation expenses, payouts and reserves...[which]
includes $1.6 billion taken in the third quarter [of 2012]...." According to
the related video, what period will be affected by $1.6 billion being
recorded as an expense related to this $2.43 billion settlement? Explain
your answer.

Bank of America Corp. agreed to pay $2.43 billion
to settle claims it misled investors about the acquisition of troubled
brokerage firm Merrill Lynch & Co., in the latest financial-crisis
aftershock to rattle the banking sector.

The payment is the largest settlement of a
shareholder claim by a financial-services firm since the upheaval of 2008
and 2009. It also ranks as the eighth-largest securities class-action
settlement, behind payouts like the $7.2 billion settlement with
shareholders of Enron Corp. and the $6.1 billion pact with WorldCom Inc.
investors, both in 2005.

The deal is a sign that U.S. banks' battle to
contain the high cost of the crisis continues to escalate, despite a
four-year slog of lawsuits, losses and profit-sapping regulations. Bank of
America's total exposure to crisis-era litigation is "seemingly
never-ending," said Sterne Agee & Leach Inc. in a note Friday.

Is the era that produced all of this legal exposure
"history?" the Sterne Agee & Leach analysts said. "Unlikely."

The settlement ends a three-year fight with a group
of five plaintiffs, including the State Teachers Retirement System of Ohio
and the Teacher Retirement System of Texas. They accused the bank and its
officers of making false or misleading statements about the health of Bank
of America and Merrill Lynch and were planning to seek $20 billion if the
case went to trial as scheduled on Oct. 22.The size of the pact highlights
how hasty acquisitions engineered during the height of the financial crisis
by Kenneth Lewis, then the bank's chief executive, are still haunting the
company four years later. Decisions to buy mortgage lender Countrywide
Financial Corp. and Merrill have forced Bank of America, run since 2010 by
Chief Executive Brian Moynihan, to set aside more than $42 billion in
litigation expenses, payouts and reserves, according to company figures. The
funds are meant to absorb a litany of Merrill-related lawsuits and claims
from investors who say Countrywide wasn't honest about the quality of
mortgage-backed securities it issued before the crisis.

That total includes $1.6 billion taken in the third
quarter to help pay for the Merrill settlement announced Friday and a
landmark $8.5 billion agreement reached last year with a group of
high-profile mortgage-bond investors.

The company's shares lost more than half their
value between when Bank of America announced its late-2008 plan to purchase
Merrill Lynch and the date the deal closed 3½ months later, wiping out $70
billion in shareholder value. The shares have fallen further since then, and
investors who owned the shares won't be made whole by the settlement.

"We find it simply amazing the sheer magnitude of
value destruction over the years," said Sterne Agee in the note issued
Friday. And "the bill is surely set to increase" as the research firm
expects the bank to reach other legal settlements over the next 12 to 24
months. Bank of America is still engaged in a legal clash with bond insurer
MBIA Inc., MBI+3.91%
which has alleged that Countrywide wasn't honest about the quality of
mortgage-backed securities it issued before the financial crisis.

The move to buy Merrill over one weekend in
September 2008 was initially hailed as a rare piece of good news during a
week when much of Wall Street appeared to be teetering on the brink. It also
vaulted the Charlotte, N.C., lender to the top of the U.S. banking heap,
capping a goal pursued over two decades by Mr. Lewis and his predecessor,
Hugh McColl.

The Merrill deal, initially valued at $50 billion
in Bank of America stock, was the "deal of a lifetime," Mr. Lewis said on
the day it was announced.

But the agreement soon became a problem as analysts
questioned whether Mr. Lewis paid too much and Merrill's losses spiraled out
of control in the weeks before the deal closed. Investor fears stemming from
the financial crisis sent shares of Bank of America and other financial
companies into free fall, and the deal was worth roughly $19 billion at its
completion on Jan. 1, 2009.

Mr. Lewis and his top executives made the decision
not to say anything publicly about the mounting problems before shareholders
signed off on the merger—a decision that formed the basis of a number of
Merrill-related suits, including an action brought by the Securities and
Exchange Commission. The bank also didn't disclose that it sought $20
billion in U.S. aid to digest Merrill, or that the deal allowed Merrill to
award up to $5.8 billion in performance bonuses. When Bank of America
threatened to pull out of the deal because of the losses, then-Treasury
Secretary Henry Paulson told Mr. Lewis that current management would be
removed if the deal wasn't completed.

The legal scrutiny surrounding the Merrill
acquisition contributed to Mr. Lewis's decision to step down at the end of
2009. Mr. Lewis's lawyer declined to comment.

"Any way you slice it, $2.4 billion is a big
number," says Kevin LaCroix, a lawyer at RT ProExec, a firm that focuses on
management-liability issues.

Bank of America executives now say Merrill, unlike
Countrywide, has become a big profit contributor, while the company
continues to work to absorb massive losses in its mortgage division. The
divisions inherited from Merrill produced $31.9 billion in net income
between 2009 and 2011 and $164.4 billion in revenue. Bank of America's total
net income over the period was just $5.5 billion, on $326.8 billion in
revenue, reflecting in part the hefty losses tied to the Countrywide deal.

"I think it's clear that Merrill is a significant
positive any way you want to look at it," said spokesman Jerry Dubrowski.

The settlement doesn't end all Merrill-related
headaches. The New York attorney general's office still is pursuing a
separate civil fraud suit relating to the Merrill takeover that began under
former Attorney General Andrew Cuomo. Defendants in that case include the
bank, Mr. Lewis and former Chief Financial Officer Joe Price. A spokesman
for New York State Attorney General Eric Schneiderman declined to comment.

It isn't known how much all shareholders will
receive as a result of the Merrill settlement announced Friday. The amount
shareholders receive will ultimately depend on how long they held the shares
and how much they paid. Mr. Lewis, also a shareholder, won't receive a
payout because defendants in the suit are excluded from the class that the
court certified.

But because the decline in Bank of America stock
was so steep—the shares fell from $32 to $14 between Sept. 12, 2008, the day
before the Merrill acquisition was announced, and the Jan. 1, 2009,
closing—no shareholders can expect to recover their full losses.

Before the settlement was reached, a targeted
recovery for at least three million shareholders who were part of the class
was $2.52 a share, said a spokesman for Ohio Attorney General Mike DeWine.
The State Teachers Retirement System of Ohio and the Ohio Public Employees
Retirement System, which held between 18 million and 20 million shares, now
expect to recover $1.19 per share, or roughly $20 million.

Continued in article

Breaking the Bank Frontline
VideoIn Breaking the Bank, FRONTLINE producer Michael Kirk
(Inside the Meltdown, Bush’s War) draws on a rare combination of high-profile
interviews with key players Ken Lewis and former Merrill Lynch CEO John Thain to
reveal the story of two banks at the heart of the financial crisis, the rocky
merger, and the government’s new role in taking over — some call it
“nationalizing” — the American banking system. Simoleon Sense, September 18,
2009 ---
http://www.simoleonsense.com/video-frontline-breaking-the-bank/
Bob Jensen's threads on the banking bailout ---
http://www.trinity.edu/rjensen/2008Bailout.htm

Merrill Lynch had a friend in Hank Paulson, but he was no friend to Bank
of America shareholdersThe ex-US Treasury Secretary has admitted telling the
Bank of America boss he might lose his job if he walked away from a merger from
Merrill Lynch. The former US Treasury Secretary says the merger was necessary
Hank Paulson warned the bank's chief executive Kenneth Lewis that the Federal
Reserve could oust him and the board if the rescue did not proceed. But Mr.
Paulson insisted that remarks he made were "appropriate." Bank of America bought
Merrill during the height of the financial crisis and suffered severe losses."Paulson admits bank merger threat," BBC News, July 15,
2009 ---
http://news.bbc.co.uk/2/hi/business/8152858.stm

Jensen Comment
Paulson's claim that his threats were "appropriate" comes as little comfort to
Bank of America shareholders who will be losing greatly because of the threats.

Bank of America is now paying a steep (fatal?) price for having purchased the
fraudulent Countrywide and Merrill Lynch companies. The poison-laced Countrywide
was a lousy investment decision. However, then CEO Kenneth D. Lewis contends
that then Treasury Secretary Hank Paulson held a gun to his head and forced BofA
to buy the deeply corrupt and poison-laced Merrill Lynch.

Jensen Comment
Arguably the worst decision in the 2008 economic bailout was Bank of America's
decision to buy the bankrupt Countrywide Financial. BofA then CEO Lewis claims
to this day that Treasury Secretary Hank Paulsen held a gun to his head and said
buy Countrywide Financial or else. Countrywide has been nothing but a cash flow
hemorrhage for BofA ever since.

Bank of America Corp shares plunged more than 20
percent on Monday, capping a three-day rout in which the largest U.S. bank
lost nearly one-third of its market value.

Monday's decline was triggered by a $10 billion
lawsuit from American International Group Inc alleging a "massive" mortgage
fraud.

The action raised new concerns about burgeoning
losses related to the bank's $2.5 billion purchase of Countrywide Financial
Corp in 2008 and prompted questions about the stability of the bank's
management team.

"The bank just can't get its hands around the
liabilities it's facing," said Paul Miller, an analyst at FBR Capital
Markets.

He said investors fear the bank will have to raise
equity to cover potential losses, diluting existing shareholdings.

Bank of America spokesman Jerry Dubrowski countered
that the bank has adequate reserves to buy back mortgages if necessary and
is comfortable with its strategic plans.

"We don't think we need to raise capital to run our
businesses," he said. "We have the right strategy and management team in
place."

In a separate court filing on Monday AIG,
challenged an $8.5 billion agreement Bank of America reached in late June to
end litigation by several large investors who bought securities backed by
subprime Countrywide loans.

New York Attorney General Eric Schneiderman and
other investors have previously tried to block that accord, saying the
settlement amount is too small.

Bank of America shares closed down $1.66 at $6.51
after earlier plunging to $6.31, their lowest since March 2009. More than
$30 billion of the company's market value has been wiped out since August 3.

Monday's drop came amid a broad market selloff, led
by financial stocks, on the first trading day after Standard & Poor's
downgraded its rating of U.S. government debt.

The shares of Citigroup Inc, another large bank,
fell 16.4 percent to $27.95.

The cost of insuring Bank of America debt against
default, an indicator of potential trouble at companies, rose roughly 50
percent on Monday to a level higher than several of the bank's main rivals,
data provider Markit said.

It now costs $310,000 a year to insure the bank's
bonds for five years, compared with $143,000 for the bonds of JP Morgan
Chase & Co, the second largest U.S. bank.

CONFIDENCE AND TRUST

AIG's lawsuit also upped the ante for Bank of
America Chief Executive Brian Moynihan, who is struggling to contain losses
from the Countrywide deal engineered by his predecessor, Kenneth Lewis.

"Brian Moynihan and the management team have not
gained the confidence and trust of investors," said Jonathan Finger, whose
Finger Interests Number One Ltd in Houston owns BofA stock and was a vocal
critic of Lewis.

Moynihan is scheduled to participate in a public
conference call on Wednesday hosted by Fairholme Capital Management LLC, one
of its largest shareholders.

"Brian will have to give the performance of his
life," said Tony Plath, a professor at the University of North Carolina at
Charlotte, where Bank of America is based.

Moynihan's saving grace might be that the bank's
board has no obvious candidates to replace him, said Miller of FBR Capital
Markets.

Some large investors appeared to have avoided some
of the debacle.

Hedge fund manager David Tepper, who has made a
fortune betting against financial company shares, sold nearly half of his
stake in Bank of America during the second quarter, according to a
regulatory filing from his company, Appaloosa Management.

"Bank of America's stock price will remain under
duress," said Michael Mullaney, who helps invest $9.5 billion at Fiduciary
Trust Co in Boston and who said his company has sold nearly all its BofA
shares.

Continued in article

Thain Pain: Merrill Lynch Bonuses of Over $1 Million to 696
Executives
Rewarded for making their company so profitable for shareholders? (Barf Alert!)Merrill Lynch quietly paid out at least one million
dollars bonus each to about 700 top executive even when the investment house was
bleeding with losses last year, a probe has revealed. They were part of 3.6
billion dollars in the firm's bonus payments in December before the announcement
of its fourth quarterly losses and takeover by Bank of America, the
investigation by the New York state Attorney General's office showed. "696
individuals received bonuses of one million dollars or more," New York Attorney
General Andrew Cuomo said of the Merrill scandal in a letter to a lawmaker
heading the House of Representatives financial services committee. "Merrill bonuses made 696 millionaires: probe," Yahoo News,
February 11, 2009 ---
http://news.yahoo.com/s/afp/20090211/bs_afp/usbankingjusticeprobecompanymerrillbofa_20090211201133

John Alexander Thain (born May 26, 1955) was the
last chairman and chief executive officer of Merrill Lynch before its merger
with Bank of America. Thain was designated to become president of global
banking, securities, and wealth management at the newly combined company, but he resigned on January 22, 2009. Bank of America lost
confidence in Thain after he failed to tell the bank about mounting losses at
Merrill in late 2008. The Associated Press
identified him as the best paid among the executives of the S&P 500 companies in
2007. On December 8, 2008, Thain gave up on pursuing a controversial bonus of
$10 million from the compensation committee at Merrill.[2] Thain also decided to
accelerate payments of bonus to employees at Merrill, giving out between $3
billion and $4 billion using money that appeared to come directly from the $15
billion Bank of America and Merrill Lynch had received from US government
taxpayers (via the Troubled Assets Relief Program). Thain has additionally
become infamous for spending $1.22 million in corporate funds to decorate his
office, even as he was asking the government for a bailout of his troubled
company.Quoted from Wikipedia ***
http://en.wikipedia.org/wiki/John_Thain
Thain has since been fired by Bank of America and has agreed to pay for over $1
million spent redecorating his new office.My
question is how Bank of America could buy Merrill without audit verification of
Merrill’s 2008 losses and cash flows --- these should've never been a surprise
to Bank of America unless Bank of America was plain stupid about accounting. The
final settlement price at a minimum could've been contingent on an audit of 2008
earnings.

Added Jensen Comment
I've never been a big fan of Merrill Lynch after repeated disclosures emerged
about the repeated frauds instigated by employees of Merrill in the 1990s. Just
do a word search on "Merrill" and note the number of frauds that are documented,
not the least of which is the Orange County massive derivatives instruments
fraud ---
http://www.trinity.edu/rjensen/FraudRotten.htm

My list of errors has
six whoppers, in chronologically order. I omit
mistakes that became clear only in hindsight,
limiting myself to those where prominent voices
advocated a different course at the time. Had these
six choices been different, I believe the inevitable
bursting of the housing bubble would have caused far
less harm.

WILD
DERIVATIVES In 1998, when Brooksley E.
Born, then chairwoman of the
Commodity Futures Trading Commission,
sought to extend its
regulatory reach into the derivatives world, top
officials of the Treasury Department, the Federal
Reserve and the Securities and Exchange Commission
squelched the idea. While her specific plan may not
have been ideal, does anyone doubt that the
financial turmoil would have been less severe if
derivatives trading had acquired a zookeeper a
decade ago?

SKY-HIGH LEVERAGE
The second error came in 2004, when the S.E.C. let
securities firms raise their leverage sharply.
Before then, leverage of 12 to 1 was typical;
afterward, it shot up to more like 33 to 1. What
were the S.E.C. and the heads of the firms thinking?
Remember, under 33-to-1 leverage, a mere 3 percent
decline in asset values wipes out a company. Had
leverage stayed at 12 to 1, these firms wouldn’t
have grown as big or been as fragile.

A SUBPRIME SURGEThe next error came in stages,
from 2004 to 2007, as subprime lending grew from a
small corner of the mortgage market into a large,
dangerous one. Lending standards fell disgracefully,
and dubious transactions became common.

Why wasn’t this
insanity stopped? There are two answers, and each
holds a lesson. One is that bank regulators were
asleep at the switch. Entranced by laissez faire-y
tales, they ignored warnings from those like Edward
M. Gramlich, then a Fed governor, who saw the
problem brewing years before the fall.

The other answer
is that many of the worst subprime mortgages
originated outside the banking system, beyond the
reach of any federal regulator. That regulatory hole
needs to be plugged.

FIDDLING ON FORECLOSURES
The government’s continuing failure to do anything
large and serious to limit foreclosures is tragic.
The broad contours of the foreclosure tsunami were
clear more than a year ago — and people like
Representative
Barney Frank, Democrat of
Massachusetts, and
Sheila C. Bair, chairwoman
of the
Federal Deposit Insurance Corporation,
were sounding alarms.

Yet the Treasury
and Congress fiddled while homes burned. Why?
Free-market ideology, denial and an unwillingness to
commit taxpayer funds all played roles. Sadly, the
problem should now be much smaller than it is.

LETTING LEHMANGOThe next whopper came in
September, when Lehman Brothers, unlike
Bear Stearnsbefore it,
was allowed to fail. Perhaps it was a case of
misjudgment by officials who deemed Lehman neither
too big nor too entangled — with other financial
institutions — to fail. Or perhaps they wanted to
make an offering to the moral-hazard gods.
Regardless, everything fell apart after Lehman.

People in the
market often say they can make money under any set
of rules, as long as they know what they are. Coming
just six months after Bear’s rescue, the Lehman
decision tossed the presumed rule book out the
window. If Bear was too big to fail, how could
Lehman, at twice its size, not be? If Bear was too
entangled to fail, why was Lehman not?

After Lehman went
over the cliff, no financial institution seemed
safe. So lending froze, and the economy sank like a
stone. It was a colossal error, and many people said
so at the time.

TARP’S DETOUR
The final major error is mismanagement of the
Troubled Asset Relief Program,
the $700 billion bailout fund.
As I wrote here last month, decisions of Henry M. Paulson Jr.,
the former Treasury secretary, about using the
TARP’s first $350 billion were an inconsistent mess.
Instead of pursuing the TARP’s intended purposes, he
used most of the funds to inject capital into banks
— which he did poorly.

To
illustrate what might have been, consider Fed
programs to buy
commercial paperand
mortgage-backed securities. These facilities do
roughly what TARP was supposed to do: buy troubled
assets. And they have breathed some life into those
moribund markets. The lesson for the new Treasury
secretary is clear: use TARP money to buy troubled
assets and to mitigate foreclosures.

Six fateful
decisions — all made the wrong way. Imagine what the
world would be like now if the housing bubble burst
but those six things were different: if derivatives
were traded on organized exchanges, if leverage were
far lower, if subprime lending were smaller and done
responsibly, if strong actions to limit foreclosures
were taken right away, if Lehman were not allowed to
fail, and if the TARP funds were used as directed.

All of this was
possible. And if history had gone that way, I
believe that the financial world and the economy
would look far less grim than they do today.

“I made a mistake in
presuming that the self-interest of organisations, specifically banks
and others, was such that they were best capable of protecting their own
shareholders,” he said.

In the second of two days of tense
hearings on Capitol Hill, Henry Waxman, chairman of the House of
Representatives, clashed with current and former regulators and with
Republicans on his own committee over blame for the financial crisis.

Mr Waxman said Mr Greenspan’s Federal
Reserve – along with the Securities and Exchange Commission and the US
Treasury – had propagated “the prevailing attitude in Washington... that
the market always knows best.”

Mr Waxman blamed the Fed for failing
to curb aggressive lending practices, the SEC for allowing credit rating
agencies to operate under lax standards and the Treasury for opposing
“responsible oversight” of financial derivatives.

Christopher Cox, chairman of the
Securities and Exchange Commission, defended himself, saying that
virtually no one had foreseen the meltdown of the mortgage market, or
the inadequacy of banking capital standards in preventing the collapse
of institutions such as Bear Stearns.

Mr Waxman accused the SEC chairman of
being wise after the event. “Mr Cox has come in with a long list of
regulations he wants... But the reality is, Mr Cox, you weren’t doing
that beforehand.”

Mr Cox blamed the fact that
Congressional responsibility was divided between the banking and
financial services committees, which regulate banking, insurance and
securities, and the agriculture committees, which regulate futures.

“This jurisdictional split threatens
to for ever stand in the way of rationalising the regulation of these
products and markets,” he said.

Mr Greenspan accepted that the crisis
had “found a flaw” in his thinking but said that the kind of heavy
regulation that could have prevented the crisis would have damaged US
economic growth. He described the past two decades as a “period of
euphoria” that encouraged participants in the financial markets to
misprice securities.

He had wrongly assumed that lending
institutions would carry out proper surveillance of their
counterparties, he said. “I had been going for 40 years with
considerable evidence that it was working very well”.

Continued in the article

Jensen Comment
In other words, he assumed the agency theory model that corporate
employees, as agents of their owners and creditors, would act hand and
hand in the best interest for themselves and their investors. But agency
theory has a flaw in that it does not understand Peter Pan.

Peter Pan, the manager of Countrywide Financial on Main
Street, thought he had little to lose by selling a fraudulent mortgage
to Wall Street. Foreclosures would be Wall Street’s problems and not his
local bank’s problems. And he got his nice little commission on the sale
of the Emma Nobody’s mortgage for $180,000 on a house worth less than
$100,000 in foreclosure. And foreclosure was almost certain in Emma’s
case, because she only makes $12,000 waitressing at the Country Café. So
what if Peter Pan fudged her income a mite in the loan application along
with the fudged home appraisal value? Let Wall Street or Fat Fannie or
Foolish Freddie worry about Emma after closing the pre-approved mortgage
sale deal. The ultimate loss, so thinks Peter Pan, will be spread over
millions of wealthy shareholders of Wall Street investment banks. Peter
Pan is more concerned with his own conventional mortgage on his precious
house just two blocks south of Main Street. This is what
happens when risk is spread even farther than Tinkerbell can fly! Read about the extent of cheating, sleaze,
and subprime sex on Main Street inAppendix U.

What happened is exactly what agency
theory posits. The fly by night mortgage brokers were agents for the
investment banks. They were given incentives to originate mortgages
which could provide benefits for divergent behavior, fraudlent
applications. There was great assemetry since the bankers had no
primary info on the borrowers. Agency theory tells us that we can
reduce agency costs with proper incentives (e.g. the originators
could be pentalized for late payments and defaults.) and/or
monitoring. What existed was a system with no incentives or
monitoring to reduce the very high agency cost. Mortgage brokers and
investment banks both enriched themselves at the expense of the
investors. That's exactly what agency theory would predict.

3. U.S auditing standards explicitly require
careful estimation of bad debts. The auditing firms failed the world when
auditing sub-prime mortgage receivables, the collateralized debt obligation
(CDOs) investments, and the credit derivative instruments sold to insure
those investments? Where were the auditing firms that were paid millions to
audit commercial and investment banks as well as Fannie Mae and Freddie
Mack?
See
http://www.trinity.edu/rjensen/2008Bailout.htm#AuditFirms

4, Subprime: Borne of Sleaze, Bribery, and Lies ---
http://www.trinity.edu/rjensen/2008Bailout.htm#Sleaze
Much of this began with good intentions to make housing credit available to
minorities and poor people in general, but politicians figured out how to
play Robin Hood with taxpayer money and used Congressional power over Fannie
Mae and Freddie Mack to do just that.

Homeowners brought a federal racketeering
lawsuit on Thursday against KB Home (KBH.N), the former Countrywide
Financial Corp and appraiser LandSafe Inc, accusing the companies of
operating a scheme to fraudulently inflate sales prices of KB homes in
Arizona and Nevada.

The lawsuit, filed in federal court in Phoenix,
claims the three companies colluded to overprice as many as 14,000 homes
in the two states by an average of $20,000, for an estimated total of
$2.8 billion between 2006 and the present. The plaintiffs seek class
action status and triple damages.

A KB Home spokeswoman said the Los
Angeles-based home builder had not seen the lawsuit and had no comment.
Calabasas, California-based Countrywide, which was acquired last year by
Bank of America (BAC.N), could not be reached for comment.

The lawsuit contends that KB and Countrywide
formed the joint venture Countrywide KB Home Loans to "rig and falsify"
appraised values of the homes they were selling and financing in the two
states.

The joint venture steered prospective buyers of
KB Homes to hand-picked appraisers at Countrywide subsidiary LandSafe
who would "come in with the appraisal at whatever number was necessary
to close the deal," the lawsuit said.

LandSafe appraisers "blatantly falsified" sales
prices for comparable properties, using prices from homes as much as 10
miles away, and citing comparable properties that were in different
planned communities, the suit said.

The homes were generally priced between
$250,000 and $350,000 -- inflated sums that homeowners discovered when
they attempted to sell their homes and hired independent appraisers,
said plaintiffs attorney Steve Berman of Hagens Berman Sobol Shapiro LLP
in Seattle.

"Most of these people were underwater from the
get-go," said Berman.

The Hagens firm filed a similar lawsuit against
KB and Countrywide earlier this year in California, citing claims under
the Racketeer Influenced and Corrupt Organizations Act and violation of
the state's unfair competition law.

The case is Nathaniel Johnson v. KB Home et
al., 2:09-CV-00972-MHB, in U.S. District Court in Arizona.

Professor Schiller at Yale assets housing prices are still overvalued
and need to come down to realityThe median value of a U.S. home in 2000 was
$119,600. It peaked at $221,900 in 2006. Historically, home prices have
risen annually in line with CPI. If they had followed the long-term trend,
they would have increased by 17% to $140,000. Instead, they skyrocketed by
86% due to Alan Greenspan’s irrational lowering of interest rates to 1%, the
criminal pushing of loans by lowlife mortgage brokers, the greed and hubris
of investment bankers and the foolishness and stupidity of home buyers. It
is now 2009 and the median value should be $150,000 based on historical
precedent. The median value at the end of 2008 was $180,100. Therefore, home
prices are still 20% overvalued. Long-term averages are created by periods
of overvaluation followed by periods of undervaluation. Prices need to fall
20% and could fall 30%.....
Watch the video on Yahoo Finance ---
Click Here
See the chart at
http://www.businessinsider.com/the-housing-chart-thats-worth-1000-words-2009-2
Also see Jim Mahar's blog at
http://financeprofessorblog.blogspot.com/2009/02/shiller-house-prices-still-way-too-high.html
Jensen Comment
In the worldwide move toward fair value accounting that replaces cost
allocation accounting, the above analysis by Professor Schiller is sobering.
It suggests how much policy and widespread fraud can generate misleading
"fair values" in deep markets with many buyers and sellers, although the
housing market is a bit more like the used car market than the stock market.
Each house and each used car are unique, non-fungible items that are many
times more difficult to update with fair value accounting relative to
fungible market securities and new car markets.

Thain
Pain: Merrill Lynch Bonuses of Over $1 Million to Each of 696 Executives
Rewarded for making their company so profitable for shareholders? (Barf
Alert!)Merrill Lynch quietly paid out at least one million
dollars bonus each to about 700 top executive even when the investment house
was bleeding with losses last year, a probe has revealed. They were part of
3.6 billion dollars in the firm's bonus payments in December before the
announcement of its fourth quarterly losses and takeover by Bank of America,
the investigation by the New York state Attorney General's office showed.
"696 individuals received bonuses of one million dollars or more," New York
Attorney General Andrew Cuomo said of the Merrill scandal in a letter to a
lawmaker heading the House of Representatives financial services committee.
"Merrill bonuses made 696 millionaires: probe," Yahoo News,
February 11, 2009 ---
http://news.yahoo.com/s/afp/20090211/bs_afp/usbankingjusticeprobecompanymerrillbofa_20090211201133

Long Time WSJ Defenders of Wall Street's Outrageous Compensation Morph
Into HypocritesAt each stage of the disaster, Mr. Black told me --
loan officers, real-estate appraisers, accountants, bond ratings agencies --
it was pay-for-performance systems that "sent them wrong." The need for new
compensation rules is most urgent at failed banks. This is not merely
because is would make for good PR, but because lavish executive bonuses
sometimes create an incentive to hide losses, to take crazy risks, and even,
according to Mr. Black, to "loot the place through seemingly normal
corporate mechanisms." This is why, he continues, it is "essential to
redesign and limit executive compensation when regulating failed or failing
banks." Our leaders may not know it yet, but this showdown between rival
populisms is in fact a battle over political legitimacy. Is Wall Street the
rightful master of our economic fate? Or should we choose a broader form of
sovereignty? Let the conservatives' hosannas turn to sneers. The market god
has failed.Thomas Frank, "Wall Street Bonuses Are an Outrage: The public
sees a self-serving system for what it," The Wall Street Journal,
February 4, 2009 ---
http://online.wsj.com/article/SB123371071061546079.html?mod=todays_us_opinionBob Jensen's threads on outrageous compensation are at
http://www.trinity.edu/rjensen/FraudConclusion.htm#OutrageousCompensation

5. Congress, perhaps intentionally under the leadership of President
Obama, is now turning the economic crisis into a perfect storm to bailout
spendthrift state governments, ailing companies and unions such as American
automobile manufacturers and the United Auto Workers, most anybody else with
a sob story.

The problem
with the current bailout is that the government may be giving money
to companies that don't have a long-term future: zombies. On paper,
for example, the Treasury Dept. says it invests Troubled Asset
Relief Program (TARP) money only in "healthy banks—banks that are
considered viable without government investment" because "they are
best positioned to increase the flow of credit in their
communities." That's the right idea. In practice, though, the
criteria aren't so stringent. Banks like Citigroup still aren't
strong enough to lend. "The bailout model is socialism," says R.
Christopher Whalen, senior vice-president for consultancy
Institutional Risk Analytics. He advocates selling failed
institutions in pieces, as was done to resolve the savings and loan
crisis in the late '80s and early '90s. In fact, Washington may be
moving toward something like that with Citigroup. When a big
employer runs into trouble, it's tempting to keep it going at any
cost. Economists call this "lemon socialism"—the investment of
public money in the worst companies rather than the best. The
impulse is misguided, says Yale University economics professor
Eduardo M. Engel. "You don't want to protect the jobs," he says.
"What you want to protect is workers' income during the transition
from one job to another." Peter Coy, "A New Menace
to the Economy: 'Zombie' Debtors Call them "zombie" companies. Many
more has-been companies will be feeding off taxpayers, investors,
and workers—sapping the lifeblood of healthier rivals," Business
Week, January 15, 2008 ---
http://www.businessweek.com/magazine/content/09_04/b4117024316675.htm?link_position=link2

After subtracting what House Democrats
hope to spend on government payrolls, health, education and welfare,
only a fifth of the original $550 billion is left for notoriously slow
infrastructure projects, such as rebuilding highways and the electricity
grid.

The Obama administration claims the
stimulus bill will "create or save three or four million jobs over the
next two years . . . with over 90% [of those jobs] in the private
sector." To prove it, they issued a report from Christina Romer,
chairman of the Council of Economic Advisers, and Jared Bernstein, chief
economic adviser to Vice President Joe Biden. Its key estimates,
however, were simply lifted from an outdated paper by Mark Zandi of
Moody's economy.com.

Mr. Zandi's current estimates have
government employment growing by 330,400 over two years as a result of
the House bill (compared with 244,000 in Bernstein-Romer paper). Yet
even that updated figure still amounts to only 8.3% of total jobs added,
even though state and local governments are to receive 39% of the funds
($214.5 billion). Spending
$214.5 billion to create or save 330,400 government jobs implies that
taxpayers are being asked to spend $646,214 per job.

Does that make sense?

Simulations with his macroeconomic
model, according to Mr. Zandi, reveal that "every dollar spent on
unemployment benefits generates an estimated $1.63 in near-term GDP." By
contrast, such "multipliers" simulate that tax cuts for business or
investors would add only 30-38 cents on the dollar.

But econometric models are parables,
not facts. The big multipliers for transfer payments and tiny
multipliers for capital taxes in Mr. Zandi's model reveal more about the
way the model was constructed than about the way the economy works. If
model builders make Keynesian assumptions, their model will generate
Keynesian results. Yet as Harvard economist Robert Barro recently
pointed out on this page, contemporary academic economic research does
not support the multipliers used to justify the House stimulus bill.

In the March 2006 IMF Research
Bulletin, economist Giovanni Ganelli summarized recent International
Monetary Fund research on fiscal policy. Several studies find that
reductions in government spending "can have expansionary effects, since
they can contribute to a consumption and investment boom owing to
altered expectations regarding future taxation."

A 2002 study of U.S. data by Roberto
Perotti of Università Bocconi did find that the effect of debt-financed
spending increases was somewhat positive, but the multiplier effect was
much less than one. A 2004 IMF study of recessions in advanced economies
likewise found that "multipliers are unlikely to exceed unity." A 2006
study of U.S. data by IMF economist Magda Kandil found the effect of
"fiscal expansion appears insignificant on aggregate demand and economic
activity."

The Perfect (Stimulus) StormA new analysis shows that California would get a
whopping $21.5 billion under an economic stimulus plan that's expected to be
approved by the House next week, making it the biggest winner among the 50
states. That's according to the National Conference of State Legislatures, which
analyzed the new spending proposals offered by House leaders.Rob Hotakainen , "California could reap
$21.5 billion from U.S. stimulus plan," The Sacramento Bee, January
24, 2009 ---
http://www.sacbee.com/capitolandcalifornia/story/1569761.html

The Less-Than-Perfect (Stimulus) Storm for IllinoisNone of the funds provided by this Act may
be made available to the State of Illinois, or any agency of the State,
unless (1) the use of such funds by the State is approved in legislation
enacted by the State after the date of the enactment of this Act, or (2) Rod
R. Blagojevich no longer holds the office of Governor of the State of
Illinois.
Draft of the Stimulus Act I’m unaware of any previous case of the Congress
dangling a bag of money over state legislators’ heads like this before. I’d
also be surprised if it fails, no matter how commanding Blagojevich looks on
“The View.” Illinois is not really in the position to turn down cash right
now. David Weigel, "Starving Out Blago," The Washington Independent,
January 26, 2009 ---
http://washingtonindependent.com/27252/starving-out-blago

The Perfect (Stimulus) Storm for Construction After the RecessionAn analysis by Forbes publications of where
most jobs will be created singles out engineering, accounting,
nursing, and information technology, along with construction
managers, computer-aided drafting specialists, and project managers.
Unemployment rates among most of these specialists are not high. The
rebuilding of "crumbling roads, bridges, and schools" highlighted by
in various speeches by President Obama is likely to make greater use
of unemployed workers in the construction sector. However, such
spending will be a small fraction of the total stimulus package, and
it is not easy for workers who helped build residential housing to
shift to building highways . . . The likelihood that such a rapid
and large public spending program will be of low efficiency is
compounded by political realities. Groups that have lots of
political clout with Congress will get a disproportionate amount of
the spending with only limited regard for the merits of the spending
they advocate compared to alternative ways to spend the stimulus.
The politically influential will also redefine various projects so
that they can fall under the "infrastructure" rubric. A report
called Ready to Go by the U.S. Conference of Mayors lists $73
billion worth of projects that they claim could be begun quickly.
These projects include senior citizen centers, recreation
facilities, and much other expenditure that are really private
consumption items, many of dubious value, that the mayors call
infrastructure spending. Recessions would be a good time to increase
infrastructure spending only if these projects can mainly utilize
unemployed resources. This does not seem to be the case in most of
the so-called infrastructure spending proposed under various
stimulus plans.Nobel Laureate Gary Becker,
The Becker-Posner Blog, January 18, 2009 ---
http://www.becker-posner-blog.com/

The Perfect (Stimulus) Storm for Signing Up Voters for the Democratic
PartyThe House Democrats’ trillion dollar spending bill,
approved on January 21 by the Appropriations Committee and headed to the
House floor next week for a vote, could open billions of taxpayer dollars to
left-wing groups like the Association of Community Organizations for Reform
Now (ACORN). ACORN has been accused of perpetrating voter registration fraud
numerous times in the last several elections; is reportedly under federal
investigation; and played a key role in the irresponsible schemes that
caused a financial meltdown that has cost American taxpayers hundreds of
billions of dollars since last fall. House Republican Leader John Boehner
(R-OH) and other Republicans are asking a simple question: what does this
have to do with job creation? Are Congressional Democrats really going to
borrow money from our children and grandchildren to give handouts to ACORN
in the name of economic “stimulus?” Incredibly, the Democrats’ bill makes
groups like ACORN eligible for a $4.19 billion pot of money for
“neighborhood stabilization activities.” Funds for this purpose were
authorized in the Housing and Economic Recovery Act, signed into law in
2008. However, these funds were limited to state and local governments. Now
House Democrats are taking the unprecedented step of making ACORN and other
groups eligible for these funds:Rick Moran, "ACORN eligible for billions from stimulus plan,"
American Thinker, January 26, 2009 ---
http://www.americanthinker.com/blog/2009/01/acorn_eligible_for_billions_fr.html
Jensen Comment
Keith Olbermann correctly points out that ACORN will not get the funds
directly but must bid competitively for such funds. What he does not explain
is why ACORN disserves to be allowed to bid for billions of bailout funds
given its biased political activities.

The group (ACORN) that pushed banks into the
risky loans that brought the economy down is now eligible for a huge chunk
of stimulus cash. The stimulus plan does create jobs — for community
activists."ACORN's Seed Money," Investor's Business Daily,
January 27, 2009 ---
http://www.ibdeditorials.com/IBDArticles.aspx?id=317952439188615
Jensen Comment
It's never too late to give jobs to register fictitious people to vote for
Democrats. Soon ACORN will have stimulus funds to register more Democrats.

The group and its web of nonprofit,
tax-exempt affiliates have collected an estimated $53 million in
government funds since 1994. This pipeline is apparently a
constitutionally protected right. According to ACORN's lawyers at the
far-left Center for Constitutional Rights, the congressional funding ban
constitutes a "bill of attainder" -- an act of the legislature declaring
a person(s) guilty of a crime without trial.

Now cue the world's smallest violin
and pass the Kleenex: ACORN's lawyers say the group has suffered
cutbacks and layoffs as a result of the punitive funding ban. The
congressional persecution means ACORN can no longer teach
first-time-homebuyer indoctrination classes and -- gasp -- the loss of
an $800,000 contract to conduct "outreach" on "asthma."

Message: The demons in the House who
defunded ACORN (345 of them, including 172 Democrats) are cutting off
oxygen to poor people!

"It's not the job of Congress to be
the judge, jury and executioner," CCR lawyer Jules Lobel moaned as he
equated the House's act of fiscal responsibility with the death penalty.

"It is outrageous to see Congress
violating the Constitution for purposes of political grandstanding," CCR
Legal Director Bill Quigley seethed without a shred of irony.

"Congress bowed to FOX News and joined
in the scapegoating of an organization that helps average Americans
going through hard times to get homes, pay their taxes and vote. Shame
on them," ACORN head Bertha Lewis piled on in an affidavit lamenting the
loss of state, local and private foundation grants, which she blamed on
the resolution. It "gave the green light for others to terminate our
funds, as well."

What ACORN's sob-story tellers leave
out is the inconvenient fact that nonprofits were bailing on ACORN long
before undercover journalists Hannah Giles and James O'Keefe and
BigGovernment.com publisher Andrew Breitbart entered the scene. Internal
ACORN records from a Washington, D.C., meeting held last August noted
that more than $2 million in foundation money was being withheld as a
result of the group's embezzlement scandal involving founder Wade
Rathke's brother, Dale -- reportedly involving upward of $5 million.

Rathke admitted he suppressed
disclosure of his brother's massive theft -- first discovered in 2000 --
because "word of the embezzlement would have put a 'weapon' into the
hands of enemies of ACORN." In other words: The protection of ACORN's
political viability came before the protection of members' dues (and
taxpayers' funds).

A small group of ACORN executives
helped cover up Dale Rathke's crime by carrying the amount he embezzled
as a "loan" on the books of Citizens Consulting Inc. CCI, the accounting
and financial management arm of ACORN and its affiliates, is housed in
the same building as the national ACORN headquarters in New Orleans.
It's also home to ACORN International, now operating under a different
name, which Wade Rathke continues to head.

ACORN brass cooked up a "restitution"
plan to allow the Rathkes to pay back a measly $30,000 a year in
exchange for secrecy about the deal. ACORN's lawyers issued a decree to
its employees to keep their "yaps" shut. Dale Rathke kept his job and
his $38,000 annual salary until the story leaked to donors and board
members outside the Rathke circle.

In June 2008, the left-wing Catholic
Campaign for Human Development cut off grant money to ACORN "because of
questions that arose about financial management, fiscal transparency and
organizational accountability of the national ACORN structures." In
November 2008 -- ahem, more than a year before the congressional ACORN
funding ban was passed -- CCHD voted unanimously to extend and make
permanent its ban on funding of ACORN organizations. "This decision was
made because of serious concerns regarding ACORN's lack of financial
transparency, organizational performance and questions surrounding
political partisanship," according to Bishop Roger Morin.

Did ACORN's lawyers call that
withdrawal of funding "political grandstanding" and "scapegoating," too?

The lawsuit over the congressional
funding ban is just the latest desperate legal measure to distract from
ACORN's long-festering ethics and financial scandals. ACORN's attorneys
have sued Giles, O'Keefe, Breitbart and former ACORN/Project Vote
whistleblower Anita MonCrief. And they'll sue anyone else who gets in
the way of rehabilitating the scandal-plagued enterprise's image.

It took decades to build up its
massive coffers and intricate web of affiliates across the country. It
will take months and years to untangle the entire operation. And it will
take time, money and relentless sunshine to dismantle the
government-subsidized partisan racket.

ACORN can never be "reformed."
It is constitutionally corrupt. Sue me.

The Perfect (Stimulus) Storm for Transfer Payments to Medicaid and the
PoorAnother "stimulus" secret is that some $252 billion
is for income-transfer payments -- that is, not investments that arguably
help everyone, but cash or benefits to individuals for doing nothing at all.
There's $81 billion for Medicaid, $36 billion for expanded unemployment
benefits, $20 billion for food stamps, and $83 billion for the earned income
credit for people who don't pay income tax. While some of that may be
justified to help poorer Americans ride out the recession, they aren't job
creators. "A 40-Year Wish List You won't believe what's in
that stimulus bill," The Wall Street Journal, January 28, 2009 ---
http://online.wsj.com/article/SB123310466514522309.html?mod=djemEditorialPage

The Perfect (Stimulus) Storm for Amtrak, Artists, Child Care
Businesses, and Global Warming ResearchWe've looked it over, and even we can't quite
believe it. There's $1 billion for Amtrak, the federal railroad that hasn't
turned a profit in 40 years; $2 billion for child-care subsidies; $50
million for that great engine of job creation, the National Endowment for
the Arts; $400 million for global-warming research and another $2.4 billion
for carbon-capture demonstration projects. There's even $650 million on top
of the billions already doled out to pay for digital TV conversion coupons."A 40-Year Wish List You won't believe what's in that
stimulus bill," The Wall Street Journal, January 28, 2009 ---
http://online.wsj.com/article/SB123310466514522309.html?mod=djemEditorialPage

The Perfect (Stimulus) Storm for Democrats in CongressThis is supposed to be a new era of bipartisanship,
but this bill was written based on the wish list of every living -- or dead
-- Democratic interest group. As Speaker Nancy Pelosi put it, "We won the
election. We wrote the bill." So they did. Republicans should let them take
all of the credit. "A 40-Year Wish List You won't believe what's in that
stimulus bill," The Wall Street Journal, January 28, 2009 ---
http://online.wsj.com/article/SB123310466514522309.html?mod=djemEditorialPage
Jensen Comment
Of course it goes without saying that it's already been a perfect (stimulus)
storm for bankers and Wall Street executives who brought on this chaos by
reckless investment in fraudulent subprime mortgages. They inadvertently
created an excuse for the largest populist spending spree in the history of
the world.

The Perfect (Stimulus) Storm for a Universal Healthcare Entitlement in
the United StatesThe more we dig into the pile of spending and tax
favors known as the "stimulus bill," the more amazing discoveries we make.
Namely, Democrats have apparently decided that the way to gun the economy is
to spend even more on health care. This is notable because if there has been
one truly bipartisan idea in Washington, it's that the U.S. as a whole
spends too much on health care. President Obama has been talking up
entitlement reform as a way to free up the money for his other social
priorities. But it turns out that Congress is using the stimulus as cover
for a massive expansion of federal entitlements. "The Entitlement Stimulus: More giant steps
toward government," The Wall Street Journal, January 29, 2009 ---
http://online.wsj.com/article/SB123318915075926757.html?mod=djemEditorialPage
Jensen Comment
On January 28, ABC News reported how the Canadian Universal Health Care Plan
was so much more efficient in terms of accounting efficiency, largely
because third party billing in the U.S. has become a quagmire. However, what
ABC failed to mention, probably deliberately, is that over half of the
average Canadian's salary is taxed mostly for health care. Much has been
made about the months or years Canadians wait for non-emergency medical
treatments. But seldom does the liberal U.S. press mention the enormous tax
bill that goes with the Canadian Universal Health Care Plan. Taxpayers need
not worry in the United States however. The new entitlement payment plan in
the U.S. simply entails printing money rather than taxing or borrowing ---
http://www.trinity.edu/rjensen/Entitlements.htm

It seems a lifetime ago, but it's only been six
months since the Congressional Budget Office put a $25 billion price tag
on the legislation to bail out Fannie Mae and Freddie Mac. At the time,
then CBO Director Peter Orszag told Congress that there was a "probably
better than 50%" chance that the government would never have to spend a
dime to shore up the two government-sponsored mortgage giants.

So much for that. In the past few days Fannie
and Freddie have requested a combined $51 billion from the Treasury to
compensate for losses in their loan portfolios. This comes on top of the
$13.8 billion that Freddie needed in November.

The latest requests take the tab to $70 billion
or so -- but that's not the end of the story by a long shot. Earlier
this month, CBO released its biannual budget outlook. And largely
ignored underneath the $1.2 trillion deficit estimate for fiscal 2009
was the little matter of a $238 billion charge for rescuing Fan and
Fred. To put that in perspective, $238 billion is more than the entire
federal budget deficit in fiscal 2007

The CBO's $238 billion estimate represents its
guess of the long-term cost of paying for the guarantees that Fannie and
Freddie write on their mortgage-backed securities. Nor is that just a
post-bubble hangover. The last $38 billion of that is for losses on new
business this year. And for all anyone knows, that number, like the
earlier estimates, is wildly optimistic.

For starters, that $238 billion doesn't include
$18 billion that the CBO expected the Treasury to lend the wonder twins
this year. But in any case we're already well beyond $18 billion on that
score: As of this week they've already requested $70 billion since the
fiscal year began -- and we still have eight months to go. So you can
add $70 billion to the $238 billion, which gets us to $308 billion --
and even that might be conservative. Rajiv Setia, an analyst at
Barclays, figures the duo will need $120 billion from Treasury this year
alone, which would mean another $50 billion on top of the $70 billion
already requested.

Back when the bailout was being debated last
July, Senator Jon Tester (D., Mont.) worried that the Fan and Fred
bailout could cost $1 trillion. Given that the two companies combined
have more than $5 trillion in debt and mortgage backed securities
outstanding, Mr. Tester's guess isn't looking worse than anyone else's.

At that same time, Senator Kent Conrad (D.,
N.D.) said that the CBO's $25 billion estimate would be "very helpful to
those who want to advance this legislation." And no doubt it was. A
spokeswoman for Fannie promoter Barney Frank said then, "we especially
like that there is less than a 50% chance that it will be used." The CBO
had figured that there was a 5% chance that losses would reach the $100
billion cap on the credit line created by the July law. Now CBO's best
guess is more than double that.

The bigger picture here is that politicians
like Mr. Frank have been telling us for years that Fannie and Freddie's
federal subsidy was a free lunch. We are now slowly, and painfully,
learning the price of Mr. Frank's famous desire to "roll the dice" with
Fan and Fred. Keep that in mind the next time you hear a politician
propose a taxpayer guarantee. The only sure thing is that the taxpayers
will pay.

In my many years I have come
to a conclusion that one useless man is a shame, two is a law firm and three or
more is a congress. John Adams

If you don't read the newspaper you are uninformed, if you do read the
newspaper you are misinformed.Mark Twain

Suppose you were an idiot. And suppose you were a member of Congress. But
then I repeat myself.Mark Twain

I contend that for a nation to try to tax itself into prosperity is like a
man standing in a bucket and trying to lift himself up by the handle.Winston Churchill

A government which robs Peter to pay Paul can always depend on the support of
Paul.George Bernard Shaw

A liberal is someone who feels a great debt to his fellow man, which debt he
proposes to pay off with your money.G. Gordon Liddy

Democracy must be something more than two wolves and a sheep voting on what
to have for dinner.James Bovard, Civil Libertarian (1994)

Foreign aid might be defined as a transfer of money from poor people in rich
countries to rich people in poor countries.Douglas Casey, Classmate of Bill Clinton at Georgetown University

Giving money and power to government is like giving whiskey and car keys to
teenage boys.P.J. O'Rourke, Civil Libertarian

Government is the great fiction, through which everybody endeavors to live
at the expense of everybody else.Frederic Bastiat, French Economist (1801-1850)

Government's view of the economy could be summed up in a few short phrases:
If it moves, tax it. If it keeps moving, regulate it. And if it stops moving,
subsidize it.Ronald Reagan (1986)

I don't make jokes. I just watch the government and report the facts.Will Rogers

13. If you think health care is expensive now, wait until you see what it costs
when it's free!P.J. O'Rourke

In general, the art of government consists of taking as much money as
possible from one party of the citizenry to give to the other.Voltaire (1764)

Just because you do not take an interest in politics doesn't mean politics
won't take an interest in you!Pericles (430 B.C.)

No man's life, liberty, or property is safe while the legislature is in
session.Mark Twain (1866)

Talk is cheap ... except when Congress does it.Anonymous

The government is like a baby's alimentary canal, with a happy appetite at
one end and no responsibility at the other. Ronald Reagan

The inherent vice of capitalism is the unequal sharing of the blessings. The
inherent blessing of socialism is the equal sharing of misery.Winston Churchill

(Good thing
Obama sent Churchill's bust back to the U.K. from the Oval Office and replaced
it with a bust of Lincoln who wrote that Government should print all the money
it needs without taxation and borrowing)

The only difference between a tax man and a taxidermist is that the
taxidermist leaves the skin.Mark Twain

The ultimate result of shielding men from the effects of folly is to fill
the world with fools.Herbert Spencer,
English Philosopher (1820-1903)

There is no distinctly native American criminal class ... save Congress.Mark Twain

What this country needs are more unemployed politicians. Edward Langley, Artist (1928-1995)

A government big enough to give you everything you want, is strong enough to
take everything you have.Thomas Jefferson

Madoff made off with $50 Billion!
Where did it go?
Who will pay it back?

Shana Madoff, whose uncle Bernie Madoff
stands accused of defrauding investors of $50 billion
(later raised to over $65 billion), is the
wife of Eric Swanson, a former top lawyer at the Securities and
Exchange Commission. A goy, but well-placed!

So well-placed that SEC chairman
Christopher Cox is now elaborately raising his eyebrows about
the relationship — especially since Shana Madoff worked as the
compliance lawyer at Bernard L. Madoff Investment Securities,
and met Swanson at a trade association event. (Can you imagine
what a swinging scene that was?)

Swanson resigned from the SEC in 2006,
and the couple married in 2007. But they clearly dated for a
while before that.

Some have suggested that Shana Madoff
is a "shopaholic." So not technically true! Why, she married the
manager of a men's clothing store in 1997, but that didn't work
out. A 2004 New York profile detailed her simultaneous affection
for Narciso Rodriguez and aversion to actually going out and
shopping. Instead of trying on clothes at the store, she had
salespeople messenger the entire collection to her office, and
charge her only for what she didn't return. The article mentions
her having a boyfriend. Was that Swanson, whom one SEC colleague
said conducted a review of Madoff's firm in 1999 and 2004?

A spokesman for Swanson — they get
flacks quickly these days, don't they — told ABC News that he
"did not participate in any inquiry of Bernard Madoff Securities
or its affiliates while involved" (it was later shown
that he was veru involved in the Madoff "investigation" while at
the SEC) with Shana Madoff. How
convenient!

But that could be said about pretty
much all of his coworkers. The SEC first fielded complaints
about the Madoff firm in 1999, but never opened a formal
investigation that would have allowed it to subpoena records. In
2006, Bernard Madoff registered as an investment advisor with
the SEC, but the agency never conducted a standard review. Are
you beginning to get a picture of why Shana Madoff, who was
charged with keeping the company out of trouble with regulators,
was so busy she couldn't even go shopping?

Swanson was at the commission in 2003
when the agency was examining the Madoff firm.
More importantly, he was also part of the SEC team that was
conducting the actual inquiry into the firm . . .
What does all this mean? Nothing, according to
Shana Madoff or her husband, whom she married in 2007. A spokesman
for Shana Madoff and one for Swanson confirm that both knew each
other professionally during the time of the examination."Madoff Victims Claim Conflict of Interest at SEC," CNBC,
December 15, 2008 ---
http://www.cnbc.com/id/28242487

Madoff made off with $50 Billion!
Where did it go?
Who will pay it back?

A Tale of Four Investors Forwarded by Dennis Beresford

Four investors made different
investment decisions 10 years ago. Investor one was extremely risk
averse so he put $1 million in a safe deposit box. Today he still
has $1 million. Investor two was a bit less risk averse so she
bought $1 million of 6% Fanny Mae Preferred. She put the $15,000
she received in dividends each quarter in a safe deposit box. After
receiving 40 dividends, she recently sold her investment for $20,000
so she now has $620,000 in her safe deposit box. Investor three was
less risk averse so he bought and held a $1 million well diversified
U.S. stock portfolio which he recently sold for $1 million, putting
the $1 million in his safe deposit box. Investor four had a friend
who knew someone who was able to invest her $1 million with Bernie
Madoff. Like clockwork, she received a $10,000 check each and every
month for 120 months. She cashed all the checks, putting the money
in her safe deposit box. She was outraged to learn that she will no
longer receive her monthly checks. Even worse, she lost all her
principal. She only has $1,200,000 in her safe deposit box. She
hopes the government will bail her out.

The many Bernard Madoff investors who withdrew
money from their accounts over the years are now wrestling with an ethical
and legal quandary. What they thought were profits was likely money stolen
from other clients in what prosecutors are calling the largest Ponzi scheme
in history. Now, they are confronting the possibility they may have to pay
some of it back.

The issue came to the forefront this week as about
8,000 former Madoff clients began to receive letters inviting them to apply
for up to $500,000 in aid from the Securities Investor Protection Corp.

Lawyers for investors have been warning clients to
do some tough math before they apply for any funds set aside for the
victims, and figure out whether they were a winner or loser in the scheme.

Hundreds and maybe thousands of investors in
Madoff's funds have been withdrawing money from their accounts for many
years. In many cases, those investors have withdrawn far more than their
principal investment.

"I had a call yesterday from a guy who said, 'I've
taken out more money then I originally put in, but I still had $1 million
left with Madoff. Should I file a $1 million claim?'" said Steven Caruso, a
New York attorney specializing in securities and investment fraud.

"I'm hard-pressed to give advice in that
situation," Caruso said.

Among the options: Get in line with other victims
looking for restitution. Keep quiet and hope nobody notices. Return the
money. Or hire a lawyer and fight to keep profits that were probably
fraudulent.

No one knows yet how many people will emerge as net
winners in the scandal, but the numbers appear to be substantial. Many of
Madoff's long-term investors have, over time, cashed out millions of dollars
of their supposed profits, which routinely amounted to 11 percent to 15
percent per year.

Jonathan Levitt, a New Jersey attorney who
represents several former Madoff clients, said more than half of the victims
who called his office looking for help have turned out to be people whose
long-term profits exceeded their principal investment.

"There are a lot of net winners," he said.

Asked for an example, Levitt said one caller, whom
he declined to name, invested $1.8 million with Madoff more than a decade
ago, then cashed out nearly $3 million worth of "profits" as the years went
by.

On paper, he still had $4 million invested with
Madoff when the scheme collapsed, but it now looks as if that figure was
almost entirely comprised of fictitious profits on investments that were
never actually made, leaving his claim to be owed anything unclear.

Other attorneys report getting similar calls.

Under federal law, the court-appointed trustee
trying to unravel Madoff's business can demand that people who profited from
the scheme return some or all of the money.

These so-called "clawbacks" are generally limited
to payouts over the last six years, but could still amount to big bucks for
some investors.

When a hedge fund run by the Bayou Group collapsed
and was revealed to be a Ponzi scheme in 2005, the trustee handling the case
sought court orders forcing investors to return false profits. Many experts
anticipate a similar process in the Madoff case.

Applying for the aid could give the trustee
evidence he needs to initiate a clawback claim. On the other hand, investors
who ignore the letter would most likely forfeit any chance of recovering
lost funds.

No matter how they respond, it may only be a matter
of time before investors wiped out in the scandal turn on those who
unknowingly enjoyed the fruits of the fraud.

"The sharks are all circling," Caruso said.

Some hedge funds that had billions of dollars
invested with Madoff are already going through years worth of records,
trying to figure out which of their investors withdrew more than they put
in.

That data could be used by the fund managers to
defend themselves against lawsuits, or go after clients deemed to have
profited from the scheme and get them to return the cash.

The future is equally cloudy for investors who
cashed out entirely before Madoff's arrest.

Continued in article

NY Post's video quiz on top scandals ---
http://www.nypost.com/entertainment/comicsgames/popjax_game.htm?gameId=1149
Bonus Question
Why are there two prices ($100 versus $5,000) for a good massage?
Madoff enjoyed "frequent massages" during work, hurled vicious insults at
underlings and physically fell to pieces as his scheme unraveled. Eleanor
Squillari, his secretary reveals in an explosive Vanity Fair article.....a
shocking, inside look at the day-to-day operations of Madoff's investment
firm....his lusty penchant for the ladies as he bilked billions. The 70-year-old
Madoff had a roving eye ...." I caught him scouting the escort pages alongside
pictures of scantily clad women." Madoff had numbers for "masseuses" in his
address book....Madoff would playfully "try to pat me on the ass" and say, "You
know it excites you" when he would exit his office bathroom zipping his fly.
Squillari said. "..... clients would frequently complain about the lack of
customer service..... Bernie would say, "Most of these customers are a pain in
the ass." As it became clear to her uber-controlling boss that he couldn't stop
his world from crashing, he started to physically buckle... "He seemed to be in
a coma. He was bunkered down in his palatial Manhattan pad with his wife, who
had been "handl[ing] all the invoices that came in," Squillari said. Dan Mangan, "BERNIE MADOFF'S LUST
FOR LADIES & MONEY (unzipped scammer liked 'massages' from females" New York
Post, May 6, 2009 ---
http://www.nypost.com/seven/05062009/news/nationalnews/lust_for_ladies__money_167836.htm?page=0

Swine Flew: Madoff's Piggy BankFor months lawyers and investors have been
asking convicted conman Bernie Madoff, "Where's the money?" We got a
partial answer to that question Wednesday from Irving Picard, the
trustee liquidating Madoff Investment Securities LLC: Madoff turned
his investment firm into his "personal piggy bank," using tens of
millions of dollars in client funds to cover costs for employees and
family members, court papers say. Madoff used money from his firm to
pay loans, satisfy capital calls, fund real estate purchases and
hire employees for his children, wife, brother and workers,
according to a filing by Picard (see below). "He essentially used
BLMIS as his 'personal piggy bank,' having BLMIS pay for his lavish
lifestyle and that of his family," David Sheehan, a lawyer for
Picard, wrote in a legal brief filed in U.S. Bankruptcy Court in New
York. "Madoff used BLMIS to siphon funds which were, in reality,
other people's money, for his personal use and the benefit of his
inner circle. Plain and simple, he stole it." "Where is Madoff's money?" The Deal, May 7,
2009 ---
http://www.thedeal.com/dealscape/2009/05/madoff_piggy_bank_money.php
Jensen Comment
But ohhh those massages.

Shana Madoff, whose uncle Bernie Madoff
stands accused of defrauding investors of $50 billion
(later raised to over $65 billion), is the
wife of Eric Swanson, a former top lawyer at the Securities and
Exchange Commission. A goy, but well-placed!

So well-placed that SEC chairman
Christopher Cox is now elaborately raising his eyebrows about
the relationship — especially since Shana Madoff worked as the
compliance lawyer at Bernard L. Madoff Investment Securities,
and met Swanson at a trade association event. (Can you imagine
what a swinging scene that was?)

Swanson resigned from the SEC in 2006,
and the couple married in 2007. But they clearly dated for a
while before that.

Some have suggested that Shana Madoff
is a "shopaholic." So not technically true! Why, she married the
manager of a men's clothing store in 1997, but that didn't work
out. A 2004 New York profile detailed her simultaneous affection
for Narciso Rodriguez and aversion to actually going out and
shopping. Instead of trying on clothes at the store, she had
salespeople messenger the entire collection to her office, and
charge her only for what she didn't return. The article mentions
her having a boyfriend. Was that Swanson, whom one SEC colleague
said conducted a review of Madoff's firm in 1999 and 2004?

A spokesman for Swanson — they get
flacks quickly these days, don't they — told ABC News that he
"did not participate in any inquiry of Bernard Madoff Securities
or its affiliates while involved" (it was later shown
that he was veru involved in the Madoff "investigation" while at
the SEC) with Shana Madoff. How
convenient!

But that could be said about pretty
much all of his coworkers. The SEC first fielded complaints
about the Madoff firm in 1999, but never opened a formal
investigation that would have allowed it to subpoena records. In
2006, Bernard Madoff registered as an investment advisor with
the SEC, but the agency never conducted a standard review. Are
you beginning to get a picture of why Shana Madoff, who was
charged with keeping the company out of trouble with regulators,
was so busy she couldn't even go shopping?

Swanson was at the commission in 2003
when the agency was examining the Madoff firm.
More importantly, he was also part of the SEC team that was
conducting the actual inquiry into the firm . . .
What does all this mean? Nothing, according to
Shana Madoff or her husband, whom she married in 2007. A spokesman
for Shana Madoff and one for Swanson confirm that both knew each
other professionally during the time of the examination."Madoff Victims Claim Conflict of Interest at SEC," CNBC,
December 15, 2008 ---
http://www.cnbc.com/id/28242487

The mystery surrounding Bernard Madoff's alleged
$50 billion Ponzi scheme deepened further yesterday after the securities
industry's watchdog said there was no evidence that the accused swindler
ever traded a single share on behalf of his clients, suggesting financial
irregularities going back to the 1960s.

Officials at the Financial Industry Regulatory
Authority, known as FINRA, told The Post that after examining more than 40
years' worth of financial records from Madoff's now-defunct broker dealer,
there are no signs that Bernard L. Madoff Investment Securities ever traded
shares on behalf of the investment-advisory business at the center of the
scandal.

The startling findings contradict statements that
Madoff's advisory clients received showing hundreds, if not thousands of
trades, completed by the broker dealer every year.

"Our investigations of Bernard Madoff's broker
dealership showed no evidence that any shares were ever traded on behalf of
his investment advisory business," a FINRA spokesman said, adding that the
regulator has looked at Madoff's books going back to 1960.

Ira Lee Sorkin, a Madoff lawyer, declined to
comment.

Madoff was arrested last month after his sons said
their father had confessed to them that his investment-advisory business was
a Ponzi scheme that had bilked $50 billion out of wealthy friends,
vulnerable charities and universities. Madoff remains free on $10 million
bail.

While his advisory business is at the center of the
scandal, all signs point to Madoff's broker dealer being a legitimate
business that traded shares wholesale on behalf of investment banks, mutual
funds and other institutions.

Madoff was previously vice chairman of FINRA's
predecessor NASD. He was also a member of the Nasdaq stock exchange, where
he served as chairman of its trading committee.

Richard Rampell, a Florida-based certified
accountant who counts as clients several of Madoff's victims, said his
review of dozens of statements supports FINRA's findings.

"Everything I saw on those statements told me that
Madoff was clearing his own trades," he said. "There was no third party
mentioned on any of those statements."

Steve Harbeck, CEO of Securities Industry
Protection Corp., the outfit overseeing the Madoff bankruptcy to ensure
clients get some sort of compensation, said his findings are similar to
FINRA's.

"I do not have any evidence to contradict that," he
said. "This is an amazing story that something like this could have gone on
undetected for so long."

Harbeck added that he believed Madoff has been
defrauding clients for at least 28 years. "I have seen evidence to that end
and I have nothing to contradict it," he said.

Question
If Madoff's stock trades were faked for 28 years, where did the cash come from
to pay some investors?

Answer
The definition of a Ponzi scheme depends upon new investors paying cash to pay
earlier investors ---
http://en.wikipedia.org/wiki/Ponzi
This almost eliminates the amount of $50 billion Madoff stole that can be
recovered for the latest investors in his investment fund.

Why Madoff's Hedge Fund Could Be Audited by
Non-registered AuditorsWe all know that Bernie Madoff's brokerage firm was
audited by an obscure 3-person accounting firm that is not registered with the
Public Company Accounting Oversight Board. This was permitted because the SEC
exempted privately owned brokerage firms from the SOX requirement that firms are
audited by registered accountants. Floyd Norris reports, in today's NY Times,
that the SEC has now quietly rescinded that exemption. As a result, firms that
audit broker-dealers for fiscal years that end December 2008 or later will have
to be registered. However, under another SOX provision, PCAOB is allowed to
inspect only audits of publicly held companies. NYTimes,
Oversight for Auditor of Madoff.
"Why an Obscure Accounting Firm Could Audit Madoff's Records," Securities Law
Professor Blog, January 9, 2008 ---
http://lawprofessors.typepad.com/securities/

Why Madoff's Hedge Fund Could Be Audited by Non-registered AuditorsWe all know that Bernie Madoff's brokerage firm was
audited by an obscure 3-person accounting firm that is not registered with the
Public Company Accounting Oversight Board. This was permitted because the SEC
exempted privately owned brokerage firms from the SOX requirement that firms are
audited by registered accountants. Floyd Norris reports, in today's NY Times,
that the SEC has now quietly rescinded that exemption. As a result, firms that
audit broker-dealers for fiscal years that end December 2008 or later will have
to be registered. However, under another SOX provision, PCAOB is allowed to
inspect only audits of publicly held companies. NYTimes,
Oversight for Auditor of Madoff.
"Why an Obscure Accounting Firm Could Audit Madoff's Records," Securities Law
Professor Blog, January 9, 2008 ---
http://lawprofessors.typepad.com/securities/

Ruth was just due to get her hair
and nails done: That's not suspicious or anything
Ruth Madoff Withdrew $15.5 Million From Madoff Brokerage Before Bust
Joe Weisenthal,
The New York Times, February 11, 2009 ---
Click Here

"We need to
get out there and get names and get unified so that we can go to the
government and make our case," she said. "Everybody has a horror
story, everybody has bills, and everybody is devastated."
Joe Bruno quoting a Madoff Hedge Fund investor, "Madoff investors
hope for bailout," Associated Press, December 18, 2008
http://www.google.com/hostednews/ap/article/ALeqM5hfAsiWtv09AYdmjEEn6e8BEaI-tgD955ECK80But government program limits claims to
$500,000 even if claims are honored.

Moral of the
story: If you want to design such a scheme (with
unlimited claims) and get away with it,
make it legal — like investments in subprime mortgages, or
investments in energy from water. Then involve as many people as
possible, so that it becomes “too big to fail.” Some of the $700
billion bailout money may actually be used to rescue some of your
investors.
Utpal Bhattacharya, "Do Bailouts Encourage Ponzi Schemes?" The
New York Times, December 18, 2008 ---
http://economix.blogs.nytimes.com/2008/12/18/do-bailouts-encourage-ponzi-schemes/?hp
Utpal Bhattacharya is finance professor at the Kelley School of
Business at Indiana University.

Banks Secretive About How Bailout
Money is SpentBut after receiving billions in aid from
U.S. taxpayers, the nation's largest banks say they can't track
exactly how they're spending the money or they simply refuse to
discuss it. "We've lent some of it. We've not lent some of it. We've
not given any accounting of, 'Here's how we're doing it,'" said
Thomas Kelly, a spokesman for JPMorgan Chase, which received $25
billion in emergency bailout money. "We have not disclosed that to
the public. We're declining to." The Associated Press contacted 21
banks that received at least $1 billion in government money and
asked four questions: How much has been spent? What was it spent on?
How much is being held in savings, and what's the plan for the rest?
None of the banks provided specific answers.
"Where'd the Bailout Money Go? Shhhh, It's a Secret,"
AccountingWeb, December 22, 2008 ---
http://accounting.smartpros.com/x64188.xml

By Friday, Oct.
3, Congress had passed a 451-page bill that President Bush
signed into law within hours. The law granted Treasury up to
$700 billion, half of which was made available right away.

Since then,
Treasury has:

sent checks totaling $168
billion in varying amounts to 116 banks;

committed another $82
billion to capitalize more banks;

bought $40 billion in
preferred shares of American International Group (AIG,
Fortune 500) so the troubled insurer could pay off an
earlier loan from the Federal Reserve;

committed $20 billion to
back any losses that the Federal Reserve Bank of New York
might incur in a new program to
lend money to owners of securities backed by credit card
debt, student loans, auto loans and small business loans;

Now, it's likely that Treasury
will ask for the second tranche of $350 billion.

Beleaguered Citigroup is upgrading its
mile-high club with a brand-new $50 million corporate jet - only this time, it's
the taxpayers who are getting screwed. Even though the bank's stock is as cheap
as a gallon of gas and it's burning through a $45 billion taxpayer-funded
rescue, the airhead execs pushed through the purchase of a new Dassault Falcon
7X, according to a source familiar with the deal. Jennifer Gould Keil and
Chuck Bennett, "Just Plane Despicable," New York Post, January 26,
2009 ---
http://www.nypost.com/seven/01262009/news/nationalnews/just_plane_despicable_152033.htm
Jensen Comment
After Citi's executives pay themselves millions in bonuses they'll need a fast
way to get out of town.

The problem with the
current bailout is that the government may be giving money to companies that
don't have a long-term future: zombies. On paper, for example, the Treasury
Dept. says it invests Troubled Asset Relief Program (TARP) money only in
"healthy banks—banks that are considered viable without government investment"
because "they are best positioned to increase the flow of credit in their
communities." That's the right idea. In practice, though, the criteria aren't so
stringent. Banks like Citigroup still aren't strong enough to lend. "The bailout
model is socialism," says R. Christopher Whalen, senior vice-president for
consultancy Institutional Risk Analytics. He advocates selling failed
institutions in pieces, as was done to resolve the savings and loan crisis in
the late '80s and early '90s. In fact, Washington may be moving toward something
like that with Citigroup. When a big employer runs into trouble, it's tempting
to keep it going at any cost. Economists call this "lemon socialism"—the
investment of public money in the worst companies rather than the best. The
impulse is misguided, says Yale University economics professor Eduardo M. Engel.
"You don't want to protect the jobs," he says. "What you want to protect is
workers' income during the transition from one job to another." Peter Coy,
"A New Menace to the Economy: 'Zombie' Debtors Call them "zombie"
companies. Many more has-been companies will be feeding off taxpayers,
investors, and workers—sapping the lifeblood of healthier rivals," Business
Week, January 15, 2008 --- http://www.businessweek.com/magazine/content/09_04/b4117024316675.htm?link_position=link2

At the same
time, HUD pressured the federally subsidized giants to lower their
loan-to-value ratios and other underwriting requirements to
accommodate minority borrowers. HUD Secretary Andrew Cuomo even
admitted that the administration was mandating a policy of
"affirmative action" lending (his words, not ours).And it was
Clinton who initially spread the subprime rot to Wall Street. To
help Fannie and Freddie reach their "affirmative action" lending
quotas, HUD in 1995 let them get affordable-housing credit for
buying subprime securities that included loans to low-income
borrowers.Less than two years later, Freddie partnered with Wall
Street investment banker Bear Stearns to issue the first
securitizations of low-income CRA loans.There's even a press release
still available on the Web that memorializes the historic deal,
which dumped hundreds of millions of dollars in the risky loans on
the market — a down payment on the hundreds of billions that were to
follow.
"The Subprime Lending Bias," Investors Business Daily,
December 19, 2008 ---
http://www.ibdeditorials.com/IBDArticles.aspx?id=314582096700459

Bank of
America (BoA) has received an extra $20bn in US government funding
and a guarantee back-stopping the losses on $118bn of its most toxic
assets in the latest bail-out of a major US financial institution.
James Quinn,
"Bank of America to receive $138bn lifeline from US," Telegraph,
January 16, 2009 ---
Click Here
Jensen Comment
The shame is that BoA owned the mortgage brokering company,
Countrywide Financial, that caused much of the mess with crappy
sub-prime loans .

Lesson One: What Really Lies Behind the Financial Crisis?According to Siegel: Financial firms bought, held and
insured large quantities of risky, mortgage-related assets on borrowed money.
The irony is that these financial giants had little need to hold these
securities; they were already making enormous profits simply from creating,
bundling and selling them. 'During dot-com IPOs of the early 1990s, the firms
that underwrote the stock offerings did not hold on to those stocks,' Siegel
says. 'They flipped them. But in the case of mortgage-backed securities, the
financial firms decided these were good assets to hold. That was their fatal
flaw.'
"Lesson One: What Really Lies Behind the Financial Crisis?" Knowledge@Wharton,
January 21, 2009 ---
http://knowledge.wharton.upenn.edu/article.cfm?articleid=2148
Jensen Comment
Lesson Two of what lies behind the financial crisis is that investment banks and
others like AIG wrote credit derivatives on the on the CDO collateralized debt
obligations that used mortgage backed securities as collateral. The companies
that wrote these derivatives did not have the insurance reserves to cover the
melt down of those CDOs. To avoid bankruptcy of giants such as AIG, the U.S.
treasury gave billions in bailout funds to cover the credit derivatives.
See Appendix E ---
http://www.trinity.edu/rjensen/2008Bailout.htm#Bailout
I think there was a hidden agenda with respect to why Hank Paulson's first
billions in bailout funds went to cover the credit derivative obligations.
See Appendix Y ---
http://www.trinity.edu/rjensen/2008Bailout.htm#HiddenAgendaDetails

How much to bail out the banks now? $3.5 trillion by one estimateA federal program to guarantee or buy bad assets from
the ailing U.S. bank sector could come with a $3.5 trillion price tag. That
would push the accumulated costs of rescuing the financial markets over the last
year through various federal loan, stock purchase, debt guarantee and other
programs close to $9 trillion and counting, with practically no end in sight for
the bad news battering the banking industry. That figure doesn't count the $825
billion economic stimulus plan also under consideration. "We expect massive
federal intervention into the financial sector from the new administration in
the coming months," says Keefe Bruyette & Woods analyst Frederick Cannon, who
calculated the $3.5 trillion figure, which is one-quarter of the banking
sector's $14 trillion in combined assets. Liz Moyer, "A TARP In The Trillions?"
Forbes, January 21, 2009 ---
http://www.forbes.com/2009/01/21/tarp-banking-treasury-biz-wall-cx_lm_0121tarp.html

Robert Shiller visits Google’s Mountain View, CA
headquarters to discuss his book “The Subprime Solution: How Today’s Global
Financial Crisis Happened, and What to Do About It.” This event took place on
October 30, 2008, as part of the Authors@Google series. The subprime mortgage
crisis has already wreaked havoc on the lives of millions of people and now it
threatens to derail the U.S. economy and economies around the world. In The
Subprime Solution, best-selling economist Robert Shiller reveals the origins of
this crisis and puts forward bold measures to solve it. He calls for an
aggressive response–a restructuring of the institutional foundations of the
financial system that will not only allow people once again to buy and sell
homes with confidence, but will create the conditions for greater prosperity in
America and throughout the deeply interconnected world economy. Robert J.
Shiller is the best-selling author of “Irrational Exuberance” and “Subprime
Solution” (both Princeton), among other books. He is the Arthur M. Okun
Professor of Economics at Yale University.
"Authors@Google: Robert Shiller," January 8, 2009 ---
http://www.ritholtz.com/blog/2009/01/authorsgoogle-robert-shiller/

AIG's bailout is getting the revisionist treatment.
The rescue hasn't been the dismal federal experience that, say, GM's has
been. Taxpayers are showing a $5 billion profit on their 53% stake in the
insurer, as of yesterday's closing price.

What's more, in the last few days, the New York Fed
liquidated the last of the complex mortgage derivatives it acquired from
AIG's counterparties as part of the bailout. Such transactions and related
fees have netted the government about $18 billion.

This is good news but requires some revising of
theories of the crisis itself. The "toxic" and "shaky" housing derivatives
that got AIG in trouble turn out, even amid the worst housing slump in 70
years, not to have been the crud many assumed they were.

A lot of renditions skip over this part, dismissing
AIG's pre-crash mortgage activities as "reckless," thereby making a mystery
of how the refinancing of AIG could be paying off so handsomely for
taxpayers. Taxpayers are making out because they bought valuable assets on
the cheap.

This is as it should be. But let's remember how AIG
got in trouble. It wrote insurance to guarantee the very senior portions of
securities derived from underlying mortgages—that is, the portions already
designed to withstand a sizeable increase in defaults.

AIG failed not because of the failure of these
securities to keep paying as expected, but because of its own promise to
fork up cash collateral if the market price of these securities fell or if
the rating agencies downgraded what they had previously rated Triple-A.

In the systemic panic that climaxed with the Lehman
failure, both things happened in spades, even as AIG itself no longer could
raise the cash to make good on its commitments. Some now claim AIG could
have waved off the collateral calls, citing exceptional circumstances. But
even that wouldn't have changed the fact that, because of the panic, AIG
itself was no longer trusted despite being chock-full of good assets.

We'll never know if the company might have finessed
its way out of its jam (quite possibly its counterparties, including Goldman
Sachs, would have acted to keep AIG afloat if the alternative of a
government bailout weren't available). Instead AIG turned to taxpayers to
finance the collateral calls it couldn't finance itself, and taxpayers took
advantage.

For all the desire to name villains and blame bad
incentives for the financial crisis, notice that panic itself was the key
player. Panic is a variable about which it's disconcertingly hard for
government to do anything useful in advance.

Panic is systemic—an uncertainty or loss of trust
in how the system will behave. Here's a simple but relevant example: What
happens to the market value of mortgages if investors lose confidence in the
legal system to permit them to foreclose on borrowers who stop paying?

We don't need to retread the history. Letting
Lehman fail was a disaster because the rescue of Bear Stearns had
conditioned the market to believe Washington wouldn't permit major
institutional failures. The mixed signals sent about Fannie and Freddie only
undermined the effort to recruit fresh capital to other financial
institutions distressed by uncertainty over the value of mortgage
securities.

AIG is the most dramatic example of the general
case. A lot of things become good or bad collateral depending on what the
government is expected to do. It's not too strong to say Washington had to
bail out AIG because the market was uncertain whether Washington would bail
out AIG. (An additional complexity we won't go into is how the Fed's QE
exercises subsequently boosted the bailout's profits.)

Let us be careful here: A host of private and
public behaviors contributed to the housing bubble and meltdown, whose
losses were destined to be felt widely. Our system has no problem
accommodating the failure of individual institutions, even very big ones.
But systemic panic always comes to the door of government. It can't be
otherwise.

Governments can try to duck this burden, as
European governments have done, only by renouncing the ability to print
money and so soiling their own credit that substituting their own credit for
the financial system's is no longer an option. Make no mistake: This would
be a real cure for too-big-to-fail if the Europeans were inclined to let the
chips fall. They're not. Instead the self-disabling governments want Germany
to supply the bailout.

"I.R.A.": This is the paramilitary group you want to sick on
thepeople who created the over-the-counter instruments and
financialderivatives that are making this financial mess much worse than
itshould have been.

"IPO": The acronym that one yells when they see their
brokerage accounts or discover the balance of the 201/K. "I’m Pissed
Off!"

"Short Squeeze": This is what you think your chair is doing
to you when you try to calculate the new balance of your investments.

"Foreclosure": The time that the stock market stops dropping
each day.

"Stock Broker": The value of your shares each day.

"Discount Broker": The value of your shares of the brokerage
firm you own.

"Bond Broker": That guy who puts up court money to get you
out of jail.

"Market Sell-off": Daily news reports.

"Selling Short": The notion you get every time you decide to
not go with one of your winning stock picks.

"Dollar Cost Averaging": Sticking with a strategy that isn’t
working.

"Market Crash": The last sound of Alec Baldwin jumping out of
the window
at the end of this SNL commercial.

"Market Rally": A church vigil for investors praying for this
stock market selling to end.

"Washington and the Jobs Market: The U.S. needs to stop pouring
money into a Keynesian cul-de-sac," The Wall Street Journal, November
7, 2009 ---
Click Here

A familiar definition of insanity is to
keep doing the same thing and expecting different results. So in the wake of
yesterday's report that the national jobless rate climbed to 10.2% in
October, we suppose we can expect the political class to demand another
"stimulus." Maybe if Congress spends another $787 billion in the name of job
creation, it can get the jobless rate up to 12% or 13%.

It's hard to imagine a more complete
repudiation of Keynesian stimulus than the evidence of the last year's job
market. We've now had two examples of such stimulus—President Bush's $160
billion effort in February 2008 and President Obama's mega-version a year
later—and neither has made even the smallest dent in employment. As the
nearby chart shows, Mr. Obama's economic advisers sold the stimulus by
saying it would keep the jobless rate below 8%. Actual results may differ,
as they say.

The economy shed another 190,000 jobs in
October, taking the total job losses to 3.5 million since January. The
larger measure of joblessness that includes marginal and part-time workers
jumped 0.5% to 17.5%. And the average hours worked in a week stayed the same
at 33.0, which means that millions of Americans working part-time will have
to become full-time before employers start hiring new workers.

Job creation typically lags coming out of
recession, and there were some signs of hope in the October report.
Temporary employment increased for the third month in a row, often a key
early sign of a healthier jobs market. The job losses for August and
September were also revised lower. But with an economic recovery clearly
under way, corporate earnings rising and productivity soaring, we should be
seeing a sharper turn in the job market.

The White House says the stimulus created
as many as one million new jobs, but this is single-entry economic
bookkeeping. No one doubted that such spending would create some jobs and
"save" others, especially in government. But such spending isn't free. Every
dollar in new government spending is taxed or borrowed from the private
economy, which might have put it to better use.

If the government takes $1 from Paul, who
would have invested it in a new business, and gives it to Peter, who spends
it on a new lawn mower, the government records it as a net gain for economic
growth via consumption. But the economy is hardly more productive as a
result. Especially with so much of the Obama stimulus going to transfer
payments—such as Medicaid and jobless benefits—the net effect on job
creation has probably been negative. The ballyhooed Keynesian multiplier
that every dollar of government spending yields 1.5 times that in economic
growth has been exposed again as false.

The policy lesson here is for both
political parties. President Bush's cave-in to Democrats in 2008 meant that
there was no debate in Washington over policies that might have produced a
much better stimulus at that early point in the recession. Like so much else
in Mr. Bush's final year, he lost his policy bearings and forgot the lesson
of 2003: A stimulating tax cut needs to be immediate, permanent and at the
margin of the next dollar earned. Instead, for the last two years, the U.S.
and most of the world have been pouring money into a Keynesian cul-de-sac.

Not that businesses can expect anything
better now from Washington. Congress's panicked response this week has been
to extend and expand the $8,000 first-time home-buyer credit and to add
another 20 weeks in jobless benefits.

A Famous Economist Explains What's Wrong With Obama's Stimulus Program
But, in terms of fiscal-stimulus proposals, it would be unfortunate if the best
Team Obama can offer is an unvarnished version of Keynes's 1936 "General Theory
of Employment, Interest and Money." The financial crisis and possible depression
do not invalidate everything we have learned about macroeconomics since 1936.
Much more focus should be on incentives for people and businesses to invest,
produce and work. On the tax side, we should avoid programs that throw money at
people and emphasize instead reductions in marginal income-tax rates --
especially where these rates are already high and fall on capital income.
Eliminating the federal corporate income tax would be brilliant. On the spending
side, the main point is that we should not be considering massive public-works
programs that do not pass muster from the perspective of cost-benefit analysis.
Just as in the 1980s, when extreme supply-side views on tax cuts were
unjustified, it is wrong now to think that added government spending is free.Robert J. Barro, "Government
Spending Is No Free Lunch: Now the Democrats are peddling voodoo
economics," The Wall Street Journal, January 22, 2009 ---
http://online.wsj.com/article/SB123258618204604599.html?mod=djemEditorialPageRobert Barro is an economics professor at Harvard
University and a senior fellow at Stanford University's Hoover Institution.

Back in the 1980s, many commentators
ridiculed as voodoo economics the extreme supply-side view that
across-the-board cuts in income-tax rates might raise overall tax revenues.
Now we have the extreme demand-side view that the so-called "multiplier"
effect of government spending on economic output is greater than one -- Team
Obama is reportedly using a number around 1.5.

To think about what this means, first
assume that the multiplier was 1.0. In this case, an increase by one unit in
government purchases and, thereby, in the aggregate demand for goods would
lead to an increase by one unit in real gross domestic product (GDP). Thus,
the added public goods are essentially free to society. If the government
buys another airplane or bridge, the economy's total output expands by
enough to create the airplane or bridge without requiring a cut in anyone's
consumption or investment.

The explanation for this magic is that
idle resources -- unemployed labor and capital -- are put to work to produce
the added goods and services.

If the multiplier is greater than 1.0, as
is apparently assumed by Team Obama, the process is even more wonderful. In
this case, real GDP rises by more than the increase in government purchases.
Thus, in addition to the free airplane or bridge, we also have more goods
and services left over to raise private consumption or investment. In this
scenario, the added government spending is a good idea even if the bridge
goes to nowhere, or if public employees are just filling useless holes. Of
course, if this mechanism is genuine, one might ask why the government
should stop with only $1 trillion of added purchases.

What's the flaw? The theory (a simple
Keynesian macroeconomic model) implicitly assumes that the government is
better than the private market at marshaling idle resources to produce
useful stuff. Unemployed labor and capital can be utilized at essentially
zero social cost, but the private market is somehow unable to figure any of
this out. In other words, there is something wrong with the price system.

John Maynard Keynes thought that the
problem lay with wages and prices that were stuck at excessive levels. But
this problem could be readily fixed by expansionary monetary policy, enough
of which will mean that wages and prices do not have to fall. So, something
deeper must be involved -- but economists have not come up with
explanations, such as incomplete information, for multipliers above one.

A much more plausible starting point is a
multiplier of zero. In this case, the GDP is given, and a rise in government
purchases requires an equal fall in the total of other parts of GDP --
consumption, investment and net exports. In other words, the social cost of
one unit of additional government purchases is one.

This approach is the one usually applied
to cost-benefit analyses of public projects. In particular, the value of the
project (counting, say, the whole flow of future benefits from a bridge or a
road) has to justify the social cost. I think this perspective, not the
supposed macroeconomic benefits from fiscal stimulus, is the right one to
apply to the many new and expanded government programs that we are likely to
see this year and next.

What do the data show about multipliers?
Because it is not easy to separate movements in government purchases from
overall business fluctuations, the best evidence comes from large changes in
military purchases that are driven by shifts in war and peace. A
particularly good experiment is the massive expansion of U.S. defense
expenditures during World War II. The usual Keynesian view is that the World
War II fiscal expansion provided the stimulus that finally got us out of the
Great Depression. Thus, I think that most macroeconomists would regard this
case as a fair one for seeing whether a large multiplier ever exists.

I have estimated that World War II raised
U.S. defense expenditures by $540 billion (1996 dollars) per year at the
peak in 1943-44, amounting to 44% of real GDP. I also estimated that the war
raised real GDP by $430 billion per year in 1943-44. Thus, the multiplier
was 0.8 (430/540). The other way to put this is that the war lowered
components of GDP aside from military purchases. The main declines were in
private investment, nonmilitary parts of government purchases, and net
exports -- personal consumer expenditure changed little. Wartime production
siphoned off resources from other economic uses -- there was a dampener,
rather than a multiplier.

We can consider similarly three other U.S.
wartime experiences -- World War I, the Korean War, and the Vietnam War --
although the magnitudes of the added defense expenditures were much smaller
in comparison to GDP. Combining the evidence with that of World War II
(which gets a lot of the weight because the added government spending is so
large in that case) yields an overall estimate of the multiplier of 0.8 --
the same value as before. (These estimates were published last year in my
book, "Macroeconomics, a Modern Approach.")

There are reasons to believe that the
war-based multiplier of 0.8 substantially overstates the multiplier that
applies to peacetime government purchases. For one thing, people would
expect the added wartime outlays to be partly temporary (so that consumer
demand would not fall a lot). Second, the use of the military draft in
wartime has a direct, coercive effect on total employment. Finally, the U.S.
economy was already growing rapidly after 1933 (aside from the 1938
recession), and it is probably unfair to ascribe all of the rapid GDP growth
from 1941 to 1945 to the added military outlays. In any event, when I
attempted to estimate directly the multiplier associated with peacetime
government purchases, I got a number insignificantly different from zero.

As we all know, we are in the middle of
what will likely be the worst U.S. economic contraction since the 1930s. In
this context and from the history of the Great Depression, I can understand
various attempts to prop up the financial system. These efforts, akin to
avoiding bank runs in prior periods, recognize that the social consequences
of credit-market decisions extend well beyond the individuals and businesses
making the decisions.

But, in terms of fiscal-stimulus
proposals, it would be unfortunate if the best Team Obama can offer is an
unvarnished version of Keynes's 1936 "General Theory of Employment, Interest
and Money." The financial crisis and possible depression do not invalidate
everything we have learned about macroeconomics since 1936.

Much more focus should be on incentives
for people and businesses to invest, produce and work. On the tax side, we
should avoid programs that throw money at people and emphasize instead
reductions in marginal income-tax rates -- especially where these rates are
already high and fall on capital income. Eliminating the federal corporate
income tax would be brilliant. On the spending side, the main point is that
we should not be considering massive public-works programs that do not pass
muster from the perspective of cost-benefit analysis. Just as in the 1980s,
when extreme supply-side views on tax cuts were unjustified, it is wrong now
to think that added government spending is free.

Keynes: The Rise, Fall, and Return of the 20th Century's Most
Influential Economist by Peter Clarke (Bloomsbury; 2009, 211
pages; $20). Examines the life and legacy of the British economist (1883-1946).

Few forecast these (2008 economic meltdown) events; although, in an outbreak of retrospective
foresight, an increasing number now claim they saw it coming. The reality is
that among all the banks, investors, academics and policy-makers, only a handful
were able to identify ahead of time the causes and potential scale of the
crisis. (The Handful were - Bill White, formerly of both the Bank of Canada and
the Bank for International Settlements; Harvard University’s Ken Rogoff; Nouriel
Roubini of New York University; Wynne Godley of Cambridge; and Bernard Connolly
of AIG Financial Products). I came acrossthis paperby Caludio Borio of BIS.Amol Agrawal, Mostly Economics Blog, December
19, 2008 ---
http://mostlyeconomics.wordpress.com/
Jensen CommentHindsight: This 2006 video makes fools out of
Ben Stein and Art Laffer and makes a hero out of Peter Schiff.To this I might add Peter Schiff. Arthur Laffer's
preditions in 2006 predictions became a sick joke. Also you
Ben Stein
lovers may have second thoughts watching him proclaim, in 2006, that the
subprime problem is going to be a "tiny" problem. Watch Peter Schiff
make fools out of
Art Laffer,
Ben Stein, and other finance “experts” in this video. Watch Ben Stein recommend that you invest heavily in Merrill
Lynch before its shares tanked. Some of these popular media "experts" need to
spend more time studying and reading and less time broadcasting
poorly-researched advice to investors. Peter Schiff, on the other hand, does his
homework. This video is really revealing about the advice we get on television.
The video is available at the Financial Rounds Blog,
November 18 at
http://financeprofessorblog.blogspot.com/2008/11/peter-schiff-prophet-from-past.htmlUpdate on the bet Art Laffer made with Peter Schiff ---
Listen to Laffer try to weasel out of paying up ---
http://www.youtube.com/watch?v=z3WjgKUf-kA

It's partly that Roubini has a new book out, but
also just that markets are in crisis (or something approaching it) yet again
and so reporters and TV hosts turn again to the man who predicted
the last crisis. Or so the story usually goes. In fact, Roubini didn't
exactly predict the crisis that began in mid-2007. As Damien Hoffman has
documented, Roubini spent several years predicting
a very different sort of crisis — one in which foreign central banks
diversifying their holdings out of Treasuries sparked a run on the dollar —
only to turn in late 2006 to warning of a U.S. housing bust and a global
"hard landing."

He still didn't give a perfectly clear or (in
retrospect) accurate vision of how exactly this would play out. Who could?
The global economy is an awfully complicated thing. And once the troubles
became apparent to all in the summer of 2007, Roubini adroitly adjusted his
forecasts to rapidly changing circumstances, weaving a gloomy but realistic
course between those who at every turn hinted that the worst was over and
the growing ranks (especially in early 2009) who predicted an uninterrupted
slide into economic and financial chaos.

Last fall, the dollar surged as the world
turned to U.S. Treasuries as a safe haven. But its recent decline has some
wondering: is the dollar headed for a crash?

Peter Schiff : Absolutely!"At some point, the world will want out of the U.S. economy, and the
dollar will rapidly lose value. The bailouts and stimulus have only worsened
our problems. We can't afford our huge government because we don't produce
enough, so we spend borrowed money. We're sealing the fate of our currency
by printing it into oblivion."

Brad Setser: Not so fast.!
"Whenever a country runs a large trade deficit for a long period of time,
there's some risk for a disorderly correction. But there are two things
mitigating that risk: the trade deficit has come down signif- icantly, and
our savings rate has gone up. If sustained, together they reduce the risk of
a crash and the needed adjustment is smaller."

Our (Newweek's) Verdict
The potential for a crash depends on what happens abroad, as the dollar's
value is relative to that of other currencies. As long as the U.S. doesn't
get left behind in a global recovery, the dollar will be fine.

Schiff is president of Euro Pacific Capital and author
of Crash Proof.
Setser is a fellow for Geoeconomics at the Council on Foreign Relations.

Jensen Comment
Since Newsweek Magazine is owned by NBC, Newsweek would never take
a position that made President Obama's policies look bad. To do otherwise might
not keep the GOP buried beneath its 2008 ashes. No other nation is entering into
trillion-dollar deficits for the next 10 years. I side with Peter Schiff 100%,
although the timing of the dollar's crash is very unpredictable. Peter Schiff
correctly predicted (and publically warned the public) well in advance that
there would be a subprime mortgage crisis and an economic collapse. But the
funds he manages did not make excess profits on these correct predictions due
largely to the fact that he predicted treasury yields would soar and the dollar
would crash long before major events transpired (if they do indeed transpire).
It's one thing to correctly predict economic happenings and quite another to
predict their timings.

One of the Most Enlightening Debates I've Ever Watched
Video of Peter Schiff Making Accurate Predictions in 2007 ---
http://www.youtube.com/watch?v=2I0QN-FYkpw
He makes Art Laffer and Ben Stein look like they should’ve instead been limited
to making commercials with Shaq. Keep in mind that at the time Bush was still
President of the United States, although the Democrats had the majorities in the
House and Senate.

I find the above video to be incredible in making
us lose your faith in “financial experts.”

Treasury statistics indicate that, at the end of
2006, foreigners held 44% of federal debt held by the public. About 66% of that
44% was held by the central banks of other countries, in particular the central
banks of Japan and China. In total, lenders from Japan and China held 47% of the
foreign-owned debt. This exposure to potential financial or political risk
should foreign banks stop buying Treasury securities or start selling them
heavily was addressed in a recent report issued by the Bank of International
Settlements which stated, "'Foreign investors in U.S. dollar assets have seen
big losses measured in dollars, and still bigger ones measured in their own
currency. While unlikely, indeed highly improbable for public sector investors,
a sudden rush for the exits cannot be ruled out completely." ---
http://en.wikipedia.org/wiki/United_States_public_debt

The
Community Reinvestment Act of 1977 coerces banks into making loans based on
political correctness, and little else, to people who can't afford them.
Enforced like never before by the Clinton administration, the regulation
destroyed credit standards across the mortgage industry, created the subprime
market, and caused the housing bubble that has now burst and left us with the
worst housing and banking crises since the Great Depression. "Stop Covering Up And Kill The CRA," Investor's Business Daily,
November 28, 2008 ---
http://www.ibdeditorials.com/IBDArticles.aspx?id=312766781716725
Jensen Comment
The CRA was not the sole cause of the housing bubble, but when combined with
Rep. Barney Frank's later coercion of Freddie Mac and Fannie Mae to buy the high
risk political correctness mortgages, the CRA added a lot of air to the housing
bubble.

Mortgage Backed Securities are like boxes of
chocolates. Criminals on Wall Street and one particular U.S. Congressional
Committee stole a few chocolates from the boxes and replaced them with turds.
Their criminal buddies at Standard & Poors rated these boxes AAA Investment
Grade chocolates. These boxes were then sold all over the world to investors.
Eventually somebody bites into a turd and discovers the crime. Suddenly nobody
trusts American chocolates anymore worldwide. Hank Paulson now wants the
American taxpayers to buy up and hold all these boxes of turd-infested
chocolates for $700 billion dollars until the market for turds returns to
normal. Meanwhile, Hank's buddies, the Wall Street criminals who stole all the
good chocolates are not being investigated, arrested, or indicted. Momma always
said: "Sniff the chocolates first Forrest." Things generally don't pass the
smell test if they came from Wall Street or from Washington DC.Forrest Gump as quoted at
http://newsgroups.derkeiler.com/Archive/Rec/rec.sport.tennis/2008-10/msg02206.html

Forrest Gump's Momma

The Sleazy Subprime Mortgage Lending Companies Have a New (actually
renewed old) Scheme to Make Billions at Taxpayer ExpenseAs if they haven't done enough damage. Thousands of
subprime mortgage lenders and brokers—many of them the very sorts of firms that
helped create the current financial crisis—are going strong. Their new strategy:
taking advantage of a long-standing federal program designed to encourage
homeownership by insuring mortgages for buyers of modest means. You read that
correctly. Some of the same people who propelled us toward the housing market
calamity are now seeking to profit by exploiting billions in federally insured
mortgages. Washington, meanwhile, has vastly expanded the availability of such
taxpayer-backed loans as part of the emergency campaign to rescue the country's
swooning economy. Chad Terhune and Robert Berner,
"FHA-Backed Loans: The New Subprime The same people whose reckless practices
triggered the global financial crisis are onto a similar scheme that could cost
taxpayers tons more," Business Week, November 19, 2008 ---
http://www.businessweek.com/magazine/content/08_48/b4110036448352.htm?link_position=link2
Jensen Comment
That's right. The greedy slime balls "Borne of Sleaze, Bribery, and Lies" are
resurfacing with Barney Frank's blessing ---
http://www.trinity.edu/rjensen/2008Bailout.htm#Sleaze

The Somali pirates, renegade Somalis known for
hijacking ships for ransom in the Gulf of Aden, are negotiating a purchase
of Citigroup.

The pirates would buy Citigroup with new debt and
their existing cash stockpiles, earned most recently from hijacking numerous
ships, including most recently a $200 million Saudi Arabian oil tanker. The
Somali pirates are offering up to $0.10 per share for Citigroup, pirate
spokesman Sugule Ali said earlier today. The negotiations have entered the
final stage, Ali said. ``You may not like our price, but we are not in the
business of paying for things. Be happy we are in the mood to offer the
shareholders anything," said Ali.

The pirates will finance part of the purchase by
selling new Pirate Ransom Backed Securities. The PRBS's are backed by the
cash flows from future ransom payments from hijackings in the Gulf of Aden.
Moody's and S&P have already issued their top
investment grade ratings for the PRBS's.

Head pirate, Ubu Kalid Shandu, said "we need a bank
so that we have a place to keep all of our ransom money. Thankfully, the
dislocations in the capital markets has allowed us to purchase Citigroup at
an attractive valuation and to take advantage of TARP capital to grow the
business even faster." Shandu added, "We don't call ourselves pirates. We
are coastguards and this will just allow us to guard our coasts better."

Michael Lewis, whose colorful reporting on
money and excess on Wall Street has made him one of the country’s most
popular business journalists, has written a new book on the financial world,
his publisher said on Tuesday.

The book, titled “Flash Boys,” will be released by
W.W. Norton & Company on March 31. A spokeswoman for Norton said the new
book “is squarely in the realm of Wall Street.”

Starling Lawrence, Mr. Lewis’s editor, said in a
statement: “Michael is brilliant at finding the perfect narrative line for
any subject. That’s what makes his books, no matter the topic, so indelibly
memorable.”

Mr. Lewis is the author of “Moneyball,” “Liar’s
Poker” and “The Big Short.”

Jensen Comment
His books are both humorous and well-researched.

Absolutely Must-See CBS Sixty Minutes Videos
You, your students, and the world in general really should repeatedly study the
following videos until they become perfectly clear!
Two of them are best watched after a bit of homework.

Video 1
CBS Sixty Minutes featured how bad things became when poison was added to loan
portfolios. This older Sixty Minutes Module is entitled "House of Cards" ---
http://www.cbsnews.com/video/watch/?id=3756665n&tag=contentMain;contentBody
This segment can be understood without much preparation except that it would
help for viewers to first read about Mervene and how the mortgage lenders
brokering the mortgages got their commissions for poisoned mortgages passed
along to the government (Freddie Mack and Fannie Mae) and Wall Street banks. On
some occasions the lenders like Washington Mutual also naively kept some of the
poison planted by some of their own greedy brokers.
The cause of this fraud was separating the compensation for brokering mortgages
from the responsibility for collecting the payments until the final payoff
dates.

My wife and I watched Videos 2 and 3 on March 14. Both videos feature one of
my favorite authors of all time, Michael Lewis, who hhs been writing (humorously
with tongue in cheek) about Wall Street scandals since he was a bond salesman on
Wall Street in the 1980s. The other person featured on in these videos is a
one-eyed physician with Asperger Syndrome who made hundreds of millions of
dollars anticipating the collapse of the CDO markets while the shareholders of
companies like Merrill Lynch, AIG, Lehman Bros., and Bear Stearns got left
holding the empty bags.

"The End," by Michael Lewis December 2008 Issue The era that
defined Wall Street is finally, officially over. Michael Lewis, who chronicled
its excess in Liar’s Poker, returns to his old haunt to figure out what went
wrong.
http://www.trinity.edu/rjensen/2008Bailout.htm#TheEnd

Liars Poker II is called "The End"
The Not-Funny Punch Line is Not Until Page 9 of This Tongue in Cheek
Explanation of the Meltdown on Wall Street!

Now I asked
Gutfreund about his biggest decision. “Yes,” he said. “They—the
heads of the other Wall Street firms—all said what an awful thing it was
to go public (beg for a government
bailout) and how could you do such a
thing. But when the temptation arose, they all gave in to it.” He agreed
that the main effect of turning a partnership into a corporation was to
transfer the financial risk to the shareholders. “When things go wrong,
it’s their problem,” he said—and obviously not theirs alone. When a Wall
Street investment bank screwed up badly enough, its risks became the
problem of the U.S. government. “It’s laissez-faire until you get in
deep shit,” he said, with a half chuckle. He was out of the game.

To this day, the willingness of a Wall Street
investment bank to pay me hundreds of thousands of dollars to dispense
investment advice to grownups remains a mystery to me. I was 24 years
old, with no experience of, or particular interest in, guessing which
stocks and bonds would rise and which would fall. The essential function
of Wall Street is to allocate capital—to decide who should get it and
who should not. Believe me when I tell you that I hadn’t the first clue.

I’d never taken an accounting course, never run
a business, never even had savings of my own to manage. I stumbled into
a job at Salomon Brothers in 1985 and stumbled out much richer three
years later, and even though I wrote a book about the experience, the
whole thing still strikes me as preposterous—which is one of the reasons
the money was so easy to walk away from. I figured the situation was
unsustainable. Sooner rather than later, someone was going to identify
me, along with a lot of people more or less like me, as a fraud. Sooner
rather than later, there would come a Great Reckoning when Wall Street
would wake up and hundreds if not thousands of young people like me, who
had no business making huge bets with other people’s money, would be
expelled from finance.

When I sat down to write my account of the
experience in 1989—Liar’s Poker, it was called—it was in the spirit of a
young man who thought he was getting out while the getting was good. I
was merely scribbling down a message on my way out and stuffing it into
a bottle for those who would pass through these parts in the far distant
future.

Unless some insider got all of this down on
paper, I figured, no future human would believe that it happened.

I thought I was writing a period piece about
the 1980s in America. Not for a moment did I suspect that the financial
1980s would last two full decades longer or that the difference in
degree between Wall Street and ordinary life would swell into a
difference in kind. I expected readers of the future to be outraged that
back in 1986, the C.E.O. of Salomon Brothers, John Gutfreund, was paid
$3.1 million; I expected them to gape in horror when I reported that one
of our traders, Howie Rubin, had moved to Merrill Lynch, where he lost
$250 million; I assumed they’d be shocked to learn that a Wall Street
C.E.O. had only the vaguest idea of the risks his traders were running.
What I didn’t expect was that any future reader would look on my
experience and say, “How quaint.”

I had no great agenda, apart from telling what
I took to be a remarkable tale, but if you got a few drinks in me and
then asked what effect I thought my book would have on the world, I
might have said something like, “I hope that college students trying to
figure out what to do with their lives will read it and decide that it’s
silly to phony it up and abandon their passions to become financiers.” I
hoped that some bright kid at, say, Ohio State University who really
wanted to be an oceanographer would read my book, spurn the offer from
Morgan Stanley, and set out to sea.

Somehow that message failed to come across. Six
months after Liar’s Poker was published, I was knee-deep in letters from
students at Ohio State who wanted to know if I had any other secrets to
share about Wall Street. They’d read my book as a how-to manual.

In the two decades since then, I had been
waiting for the end of Wall Street. The outrageous bonuses, the slender
returns to shareholders, the never-ending scandals, the bursting of the
internet bubble, the crisis following the collapse of Long-Term Capital
Management: Over and over again, the big Wall Street investment banks
would be, in some narrow way, discredited. Yet they just kept on
growing, along with the sums of money that they doled out to
26-year-olds to perform tasks of no obvious social utility. The
rebellion by American youth against the money culture never happened.
Why bother to overturn your parents’ world when you can buy it, slice it
up into tranches, and sell off the pieces?

At some point, I gave up waiting for the end.
There was no scandal or reversal, I assumed, that could sink the system.

The New Order The crash did more than wipe out
money. It also reordered the power on Wall Street. What a Swell Party A
pictorial timeline of some Wall Street highs and lows from 1985 to 2007.
Worst of Times Most economists predict a recovery late next year. Don’t
bet on it. Then came Meredith Whitney with news. Whitney was an obscure
analyst of financial firms for Oppenheimer Securities who, on October
31, 2007, ceased to be obscure. On that day, she predicted that
Citigroup had so mismanaged its affairs that it would need to slash its
dividend or go bust. It’s never entirely clear on any given day what
causes what in the stock market, but it was pretty obvious that on
October 31, Meredith Whitney caused the market in financial stocks to
crash. By the end of the trading day, a woman whom basically no one had
ever heard of had shaved $369 billion off the value of financial firms
in the market. Four days later, Citigroup’s C.E.O., Chuck Prince,
resigned. In January, Citigroup slashed its dividend.

From that moment, Whitney became E.F. Hutton:
When she spoke, people listened. Her message was clear. If you want to
know what these Wall Street firms are really worth, take a hard look at
the crappy assets they bought with huge sums of ­borrowed money, and
imagine what they’d fetch in a fire sale. The vast assemblages of highly
paid people inside the firms were essentially worth nothing. For better
than a year now, Whitney has responded to the claims by bankers and
brokers that they had put their problems behind them with this
write-down or that capital raise with a claim of her own: You’re wrong.
You’re still not facing up to how badly you have mismanaged your
business.

Rivals accused Whitney of being overrated;
bloggers accused her of being lucky. What she was, mainly, was right.
But it’s true that she was, in part, guessing. There was no way she
could have known what was going to happen to these Wall Street firms.
The C.E.O.’s themselves didn’t know.

Now, obviously, Meredith Whitney didn’t sink
Wall Street. She just expressed most clearly and loudly a view that was,
in retrospect, far more seditious to the financial order than, say,
Eliot Spitzer’s campaign against Wall Street corruption. If mere scandal
could have destroyed the big Wall Street investment banks, they’d have
vanished long ago. This woman wasn’t saying that Wall Street bankers
were corrupt. She was saying they were stupid. These people whose job it
was to allocate capital apparently didn’t even know how to manage their
own.

At some point, I could no longer contain
myself: I called Whitney. This was back in March, when Wall Street’s
fate still hung in the balance. I thought, If she’s right, then this
really could be the end of Wall Street as we’ve known it. I was curious
to see if she made sense but also to know where this young woman who was
crashing the stock market with her every utterance had come from.

It turned out that she made a great deal of
sense and that she’d arrived on Wall Street in 1993, from the Brown
University history department. “I got to New York, and I didn’t even
know research existed,” she says. She’d wound up at Oppenheimer and had
the most incredible piece of luck: to be trained by a man who helped her
establish not merely a career but a worldview. His name, she says, was
Steve Eisman.

Eisman had moved on, but they kept in touch.
“After I made the Citi call,” she says, “one of the best things that
happened was when Steve called and told me how proud he was of me.”

Having never heard of Eisman, I didn’t think
anything of this. But a few months later, I called Whitney again and
asked her, as I was asking others, whom she knew who had anticipated the
cataclysm and set themselves up to make a fortune from it. There’s a
long list of people who now say they saw it coming all along but a far
shorter one of people who actually did. Of those, even fewer had the
nerve to bet on their vision. It’s not easy to stand apart from mass
hysteria—to believe that most of what’s in the financial news is wrong
or distorted, to believe that most important financial people are either
lying or deluded—without actually being insane. A handful of people had
been inside the black box, understood how it worked, and bet on it
blowing up. Whitney rattled off a list with a half-dozen names on it. At
the top was Steve Eisman.

Steve Eisman entered finance about the time I
exited it. He’d grown up in New York City and gone to a Jewish day
school, the University of Pennsylvania, and Harvard Law School. In 1991,
he was a 30-year-old corporate lawyer. “I hated it,” he says. “I hated
being a lawyer. My parents worked as brokers at Oppenheimer. They
managed to finagle me a job. It’s not pretty, but that’s what happened.”

He was hired as a junior equity analyst, a
helpmate who didn’t actually offer his opinions. That changed in
December 1991, less than a year into his new job, when a subprime
mortgage lender called Ames Financial went public and no one at
Oppenheimer particularly cared to express an opinion about it. One of
Oppenheimer’s investment bankers stomped around the research department
looking for anyone who knew anything about the mortgage business.
Recalls Eisman: “I’m a junior analyst and just trying to figure out
which end is up, but I told him that as a lawyer I’d worked on a deal
for the Money Store.” He was promptly appointed the lead analyst for
Ames Financial. “What I didn’t tell him was that my job had been to
proofread the ­documents and that I hadn’t understood a word of the
fucking things.”

Ames Financial belonged to a category of firms
known as nonbank financial institutions. The category didn’t include
J.P. Morgan, but it did encompass many little-known companies that one
way or another were involved in the early-1990s boom in subprime
mortgage lending—the lower class of American finance.

The second company for which Eisman was given
sole responsibility was Lomas Financial, which had just emerged from
bankruptcy. “I put a sell rating on the thing because it was a piece of
shit,” Eisman says. “I didn’t know that you weren’t supposed to put a
sell rating on companies. I thought there were three boxes—buy, hold,
sell—and you could pick the one you thought you should.” He was
pressured generally to be a bit more upbeat, but upbeat wasn’t Steve
Eisman’s style. Upbeat and Eisman didn’t occupy the same planet. A hedge
fund manager who counts Eisman as a friend set out to explain him to me
but quit a minute into it. After describing how Eisman exposed various
important people as either liars or idiots, the hedge fund manager
started to laugh. “He’s sort of a prick in a way, but he’s smart and
honest and fearless.”

“A lot of people don’t get Steve,” Whitney
says. “But the people who get him love him.” Eisman stuck to his sell
rating on Lomas Financial, even after the company announced that
investors needn’t worry about its financial condition, as it had hedged
its market risk. “The single greatest line I ever wrote as an analyst,”
says Eisman, “was after Lomas said they were hedged.” He recited the
line from memory: “ ‘The Lomas Financial Corp. is a perfectly hedged
financial institution: It loses money in every conceivable interest-rate
environment.’ I enjoyed writing that sentence more than any sentence I
ever wrote.” A few months after he’d delivered that line in his report,
Lomas Financial returned to bankruptcy.

Lewis writes in Partnoy’s earlier whistleblower
style with somewhat more intense and comic portrayals of the major
players in describing the double dealing and break down of integrity on
the trading floor of Salomon Brothers.

Steve Kroft examines the complicated financial instruments known as credit
default swaps and the central role they are playing in the unfolding economic
crisis. The interview features my hero Frank Partnoy. I don't know of
anybody who knows derivative securities contracts and frauds better than Frank
Partnoy, who once sold these derivatives in bucket shops. You can find links to
Partnoy's books and many, many quotations at
http://www.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds

For years I've used the term "bucket shop" in financial securities marketing
without realizing that the first bucket shops in the early 20th Century were
bought and sold only gambles on stock pricing moves, not the selling of any
financial securities. The analogy of a bucket shop would be a room full of
bookies selling bets on NFL playoff games.
See "Bucket Shop" at
http://en.wikipedia.org/wiki/Bucket_shop_(stock_market)

In a hearing today before the House Oversight
Committee, the credit rating agencies are being portrayed as
profit-hungry institutions that would give any deal their blessing for
the right price.

Case in point: this instant message exchange between two unidentified
Standard & Poor's officials about a mortgage-backed security deal on
4/5/2007:

Official #1: Btw (by the way) that deal is ridiculous.

Official #2: I know right...model def (definitely) does not capture half
the risk.

Official #1: We should not be rating it.

Official #2: We rate every deal. It could be structured by cows and we
would rate it.

A former executive of Moody's says
conflicts of interest got in the way of rating agencies properly valuing
mortgage backed securities.

Former Managing Director Jerome Fons, who worked at Moody's until August
of 2007, says Moody's was focused on "maxmizing revenues," leading it to
make the firm more "issuer friendly."

The three firms that dominate the $5 billion-a-year
credit rating industry - Standard & Poor's, Moody's Investors Service and Fitch
Ratings - have been faulted for failing to identify risks in subprime mortgage
investments, whose collapse helped set off the global financial crisis. The
rating agencies had to downgrade thousands of securities backed by mortgages as
home-loan delinquencies have soared and the value of those investments
plummeted. The downgrades have contributed to hundreds of billions in losses and
writedowns at major banks and investment firms. The agencies are crucial
financial gatekeepers, issuing ratings on the creditworthiness of public
companies and securities. Their grades can be key factors in determining a
company's ability to raise or borrow money, and at what cost which securities
will be purchased by banks, mutual funds, state pension funds or local
governments. A yearlong review by the SEC, which issued the results last summer,
found that the three big (credit rating) agencies failed to rein in conflicts of
interest in giving high ratings to risky securities backed by subprime
mortgages.
"SEC Puts Off Vote on Rules for Rating Agencies," AccountingWeb, November
19, 2008 ---
http://accounting.smartpros.com/x63855.xml
Jensen Comment
It’s beginning to look like Wall Street is rearing up once again to prevent the
SEC from imposing reforms on credit rating agencies. In spite of the crisis, it
will once again be business as usual with the credit rating agencies having
conflicts of interest not in the interest of investors.

A
democracy cannot exist as a permanent form of government. It can only exist
until the voters discover that they can vote themselves largesse from the
public treasury. From that moment on, the majority always votes for the
candidates promising the most benefits from the public treasury, with the
result that a democracy always collapses over loose fiscal policy, always
followed by a dictatorship.Alexander Tyler. 1787 - Tyler was a Scottish history professor that
had this to say about 2000 years after "The Fall of the Athenian Republic"
and about the time our original 13 states adopted their new constitution.
As quoted at
http://www.babylontoday.com/national_debt_clock.htm (where the debt
clock in real time is a few months behind)
This leads to contemplation of democracy versus a "social
contract."

The broad mass of a nation will more easily fall
victim to a big lie than to a small one. Adolph Hitler, Mein Kampf.

Bankers (Men in Black) bet with their
bank's capital, not their own. If the bet goes right, they get a
huge bonus; if it misfires, that's the shareholders' problem.Sebastian Mallaby.
Council on Foreign Relations, as quoted by Avital Louria Hahn,
"Missing: How Poor Risk-Management Techniques Contributed to
the Subprime Mess," CFO
Magazine, March 2008, Page 53 ---
http://www.cfo.com/article.cfm/10755469/c_10788146?f=magazine_featured
Jensen Comment
Now that the Government is going to bail out these speculators with
taxpayer funds makes it all the worse. I received an email
message claiming that if you had purchased $1,000 of AIG
stock one year ago, you would have $42 left; with Lehman, you
would have $6.60 left; with Fannie or Freddie, you would have
less than $5 left. But if you had purchased $1,000 worth of beer
one year ago, drank all of the beer, then turned in the cans for
the aluminum recycling REFUND, you would have had $214. Based on
the above, the best current investment advice is to drink
heavily and recycle. It's called the 401-Keg. Why let others
gamble your money away when you can piss it away on your own?

High-ranking members of Congress were flown to a
lush Caribbean resort this month for a three-day conference planned and paid for
by several of the country's most powerful corporations - a violation of federal
ethics rules, critics say. . . . Officials with those companies were
observed at the conference - sometimes acting as featured speakers at daily
seminars and freely mingling among the pols at social events. Citigroup - which just last week received a massive
bailout from the federal government - was one of the conference's biggest
sponsors, ponying up $100,000 to help finance
the event, according to one of the lobbyists at the gathering. Ginger Adams Otis, "SHADY ISLAND
'HOUSE' PARTY POLS' TRIP TO CARIBBEAN SKIRTED RULES," New York Post,
November 30, 2008 ---
http://www.nypost.com/seven/11302008/news/regionalnews/shady_island_house_party_141513.htm

The current financial turmoil shows that private
sector can bankrupt nation states. The US government has committed more than $5
trillion and the UK has committed around £500 billion, nearly one-third of their
respective GDPs, to support the financial sector. The bailouts may stabilise the
financial sector and help economic recovery but they have also created new moral
hazards. In the absence of effective regulation and accountability, company
directors, who have already behaved badly, will continue to behave recklessly
and play their selfish games, at virtually no cost to themselves. Leaders of
major industrialised countries have paid little attention to moral hazards and
how bailouts reward bad behaviour. There is an urgent need to address the moral
hazards problem.
Prem Sikka, "Hold them to account: The traditional mechanisms for disciplining,"
The Guardian, November 18, 2008 ---
http://www.guardian.co.uk/commentisfree/2008/nov/18/marketturmoil-banks

However, the looting of the taxpayers, which was
initially $700 billion for Wall Street and has now ballooned to an estimated
$1.8 (now closer to $5) trillion and is not over yet, was not labeled as corruption by our media.
Instead, it was called a “rescue” and was demanded by many anchors and
reporters. We were told it would stabilize the markets and help ordinary people.
It didn’t. Kevin Howley, Associate Professor of Communication at DePauw
University, says this was deliberate propaganda on their part. He comments that
“…the phrase ‘bailout’―with its connotation that the government is letting Wall
Street off the hook for questionable business practices―has given way to a far
more agreeable term― ‘rescue plan.’ This phrasing appeals to the basic decency
of the American people and suggests that we’re all in this thing together.” In a
real-life corruption case, which was just as suspiciously timed as the financial
crisis itself, Alaska Senator Ted Stevens was indicted and then convicted in
this election year on all seven charges of making false statements on Senate
financial documents. One of the charges was that he had received a $1,000
Alaskan sled dog puppy that he valued at only $250 and claimed had come from a
charity. This is chicken feed compared to what the politicians and their
appointees have done by bringing the U.S. to the point of bankruptcy. But can we
ever expect the Department of Justice to turn on the politicians for these
financial crimes? Not likely. Cliff Kincaid, "The Financial
“Rescue” that Bankrupted America," Accuracy in the Media, November 9,
2008 ---
http://www.aim.org/aim-column/the-financial-rescue-that-bankrupted-america/

This sure beats having the government buy the garbage!
If your executives got you into garbage investments, pay their bonuses in
garbage.

From the "Best of the Web Today" newsletter of The Wall Street Journal
on December 19, 2008

A Financial Innovation Everyone Should Love"Credit Suisse Group AG's investment bank has found a
new way to reduce the risk of losses from about $5 billion of its most
illiquid loans and bonds: using them to pay employees' year-end bonuses,"
Bloomberg reports:

The bank will use leveraged loans and commercial
mortgage- backed debt, some of the securities blamed for generating the
worst financial crisis since the Great Depression, to fund executive
compensation packages, people familiar with the matter said. The new
policy applies only to managing directors and directors, the two most
senior ranks at the Zurich-based company, according to a memo sent to
employees today.

"While the solution we have come up with may not
be ideal for everyone, we believe it strikes the appropriate balance
among the interests of our employees, shareholders and regulators and
helps position us well for 2009," Chief Executive Officer Brady Dougan
and Paul Calello, CEO of the investment bank, said in the memo.

The securities will be placed into a so-called
Partner Asset Facility, and affected employees at the bank,
Switzerland's second biggest, will be given stakes in the facility as
part of their pay. Bonuses will take the first hit should the securities
decline further in value.

This is such a great idea, we're
surprised it took this long for someone to think of it. And contrary to the
memo, this does seem "ideal for everyone." Shareholders gets relief from the
risk associated with imprudent investments. Credit Suisse executives get
their bonuses despite having made those imprudent investments--and if the
risk pays off, they get the reward. What's not to like?

Not only have individual financial institutions
become less vulnerable to shocks from underlying risk factors, but also the
financial system as a whole has become more resilient.Alan Greenspan in 2004 as quoted by Peter S.
Goodman, Taking a Good Look at the Greenspan Legacy," The New York Times,
October 8, 2008 ---
http://www.nytimes.com/2008/10/09/business/economy/09greenspan.html?em

The problem is not that the contracts
failed, he says. Rather, the people using them got greedy. A lack of
integrity spawned the crisis, he argued in a speech a week ago at Georgetown
University, intimating that those peddling derivatives were not as reliable
as “the pharmacist who fills the prescription ordered by our physician.”

But others hold a starkly different view
of how global markets unwound, and the role that Mr. Greenspan played in
setting up this unrest.

“Clearly, derivatives are a centerpiece of
the crisis, and he was the leading proponent of the deregulation of
derivatives,” said Frank Partnoy, a law professor at the University of San
Diego and an expert on financial regulation.

The derivatives market is $531 trillion,
up from $106 trillion in 2002 and a relative pittance just two decades ago.
Theoretically intended to limit risk and ward off financial problems, the
contracts instead have stoked uncertainty and actually spread risk amid
doubts about how companies value them.

If Mr. Greenspan had acted differently
during his tenure as Federal Reserve chairman from 1987 to 2006, many
economists say, the current crisis might have been averted or muted.

Over the years, Mr. Greenspan helped
enable an ambitious American experiment in letting market forces run free.
Now, the nation is confronting the consequences.

Derivatives were created to soften — or in
the argot of Wall Street, “hedge” — investment losses. For example, some of
the contracts protect debt holders against losses on mortgage securities.
(Their name comes from the fact that their value “derives” from underlying
assets like stocks, bonds and commodities.) Many individuals own a common
derivative: the insurance contract on their homes.

On a grander scale, such contracts allow
financial services firms and corporations to take more complex risks that
they might otherwise avoid — for example, issuing more mortgages or
corporate debt. And the contracts can be traded, further limiting risk but
also increasing the number of parties exposed if problems occur.

Throughout the 1990s, some argued that
derivatives had become so vast, intertwined and inscrutable that they
required federal oversight to protect the financial system. In meetings with
federal officials, celebrated appearances on Capitol Hill and heavily
attended speeches, Mr. Greenspan banked on the good will of Wall Street to
self-regulate as he fended off restrictions.

Ever since housing began to collapse, Mr.
Greenspan’s record has been up for revision. Economists from across the
ideological spectrum have criticized his decision to let the nation’s real
estate market continue to boom with cheap credit, courtesy of low interest
rates, rather than snuffing out price increases with higher rates. Others
have criticized Mr. Greenspan for not disciplining institutions that lent
indiscriminately.

But whatever history ends up saying about
those decisions, Mr. Greenspan’s legacy may ultimately rest on a more deeply
embedded and much less scrutinized phenomenon: the spectacular boom and
calamitous bust in derivatives trading.

“I made a mistake in
presuming that the self-interest of organisations, specifically banks and
others, was such that they were best capable of protecting their own
shareholders,” he said.

In the second of two days of tense
hearings on Capitol Hill, Henry Waxman, chairman of the House of
Representatives, clashed with current and former regulators and with
Republicans on his own committee over blame for the financial crisis.

Mr Waxman said Mr Greenspan’s Federal
Reserve – along with the Securities and Exchange Commission and the US
Treasury – had propagated “the prevailing attitude in Washington... that the
market always knows best.”

Mr Waxman blamed the Fed for failing to
curb aggressive lending practices, the SEC for allowing credit rating
agencies to operate under lax standards and the Treasury for opposing
“responsible oversight” of financial derivatives.

Christopher Cox, chairman of the
Securities and Exchange Commission, defended himself, saying that virtually
no one had foreseen the meltdown of the mortgage market, or the inadequacy
of banking capital standards in preventing the collapse of institutions such
as Bear Stearns.

Mr Waxman accused the SEC chairman of
being wise after the event. “Mr Cox has come in with a long list of
regulations he wants... But the reality is, Mr Cox, you weren’t doing that
beforehand.”

Mr Cox blamed the fact that Congressional
responsibility was divided between the banking and financial services
committees, which regulate banking, insurance and securities, and the
agriculture committees, which regulate futures.

“This jurisdictional split threatens to
for ever stand in the way of rationalising the regulation of these products
and markets,” he said.

Mr Greenspan accepted that the crisis had
“found a flaw” in his thinking but said that the kind of heavy regulation
that could have prevented the crisis would have damaged US economic growth.
He described the past two decades as a “period of euphoria” that encouraged
participants in the financial markets to misprice securities.

He had wrongly assumed that lending
institutions would carry out proper surveillance of their counterparties, he
said. “I had been going for 40 years with considerable evidence that it was
working very well”.

Continued in the article

Jensen Comment
In other words, he assumed the agency theory model that corporate employees,
as agents of their owners and creditors, would act hand and hand in the best
interest for themselves and their investors. But agency theory has a flaw in
that it does not understand Peter Pan.

Long Time WSJ Defenders of Wall Street's Outrageous Compensation Morph
Into HypocritesAt each stage of the disaster, Mr. Black told me --
loan officers, real-estate appraisers, accountants, bond ratings agencies -- it
was pay-for-performance systems that "sent them wrong." The need for new
compensation rules is most urgent at failed banks. This is not merely because is
would make for good PR, but because lavish executive bonuses sometimes create an
incentive to hide losses, to take crazy risks, and even, according to Mr. Black,
to "loot the place through seemingly normal corporate mechanisms." This is why,
he continues, it is "essential to redesign and limit executive compensation when
regulating failed or failing banks." Our leaders may not know it yet, but this
showdown between rival populisms is in fact a battle over political legitimacy.
Is Wall Street the rightful master of our economic fate? Or should we choose a
broader form of sovereignty? Let the conservatives' hosannas turn to sneers. The
market god has failed.Thomas Frank,
"Wall Street Bonuses Are an Outrage: The public sees a self-serving system
for what it,"The Wall Street Journal, February 4, 2009 ---
http://online.wsj.com/article/SB123371071061546079.html?mod=todays_us_opinion
Bob Jensen's threads on outrageous compensation are at
http://www.trinity.edu/rjensen/FraudConclusion.htm#OutrageousCompensation
Bob Jensen's threads on the Bailout mess are at
http://www.trinity.edu/rjensen/2008Bailout.htm
Bob Jensen's threads on corporate governance are at
http://www.trinity.edu/rjensen/Fraud001.htm#Governance

Peter Pan, the manager of Countrywide Financial on Main Street, thought he had
little to lose by selling a fraudulent mortgage to Wall Street. Foreclosures
would be Wall Street’s problems and not his local bank’s problems. And he got
his nice little commission on the sale of the Emma Nobody’s mortgage for
$180,000 on a house worth less than $100,000 in foreclosure. And foreclosure was
almost certain in Emma’s case, because she only makes $12,000 waitressing at the
Country Café. So what if Peter Pan fudged her income a mite in the loan
application along with the fudged home appraisal value? Let Wall Street or Fat
Fannie or Foolish Freddie worry about Emma after closing the pre-approved
mortgage sale deal. The ultimate loss, so thinks Peter Pan, will be spread over
millions of wealthy shareholders of Wall Street investment banks. Peter Pan is
more concerned with his own conventional mortgage on his precious house just two
blocks south of Main Street. This is what happens when risk is
spread even farther than Tinkerbell can fly! Read about the extent of cheating, sleaze, and
subprime sex on Main Street in
Appendix U.

Banks and homeowners aren't the only
ones looking to Washington for help these days. The nation's automakers are
bleeding red ink. Given the Big Three's outsize role in the U.S. economy, it may
make sense for taxpayers to lend Detroit a helping hand, argue David Kiley and
David Welch in a provocative essay. While Republicans in Washington have been
expanding the role of government in financial services, microcredit pioneer
Muhammad Yunus, of Bangladesh's Grameen Bank, is advocating a market-based
solution to the financial crisis. Monica Gagnier, "The Fed's Next
Step," Business Week's Insider Newsletter, October 17, 2008
Jensen Comment
The latest trend is that government will bail out failing industries like banks,
automobile manufacturers, and airlines. And why not? The
government can spend trillions doing so without costing taxpayers a penny
---
http://www.trinity.edu/rjensen/2008bailout.htm#NationalDebt

On the left side, there is
nothing right... And on the right side, there is nothing left. The December 31, 2008 Statement of Financial
Position (a fancy phrase for the balance sheet) of every investment bank.
The meanings in English are so varied for some words like "right" and "left."
Fat Fannie and Fearless Freddie leaned too far to the left on the left end of
the Congressional roof and fell into a pile of leftist Acorns.
Now there's nothing left but millions of empty homes left behind when the
owners left.

Governmental Accounting 101
Tutorial, by Dr. Seuss
Because of future property taxes, insurance costs, and upkeep costs, it's not
clear to accountants if Fannie and Freddie should put their foreclosed homes on
the right-side or the left-side of the balance sheet. But now that Freddie and
Fannie are owned by the government, the GAO tells us that on balance sheets the
left goes right and the right goes left. It's so confusing, but then in the
Federal Government's balance sheet nearly everything bad is left out entirely so
who cares what appears of the left versus what appears on the right. Nothing is
correct in the first place.

A more palatable approach would
be for the government to drive a Warren Buffett style hard bargain, in which,
rather than buying anything from banks, the government would invest in them in a
form, such as purchase of newly issued preferred stock, or bonds with a long
maturity, that would augment the banks' capital and thus enable banks to make
more loans. That would avoid conferring a windfall on the banks by overpaying
them for their bad securities; no one thinks Buffett is conferring a windfall on
Goldman Sachs. After the industry was back on its feet, the government could
sell the bank stocks or bonds that it had acquired. Richard Posner, "The $700+ Billion Bailout," The Becker-Posner Blog,
September 28, 2008 ---
http://www.becker-posner-blog.com/
Jensen Comment
This appears to be a solution the government is belatedly adopting.

Current U.S. budget policy is
unsustainable because it violates the intertemporal budget constraint. While the
resulting fiscal gap will eventually be eliminated whether we like it or not,
the big issue in current budget debate is whether the ultimately unavoidable
course corrections should start now or be left for later. This paper argues that
concerns of generational equity, which often are relied on by those demanding a
prompt course correction, do not convincingly settle the issue, given empirical
uncertainties about future generations' circumstances. However, efficiency
issues create powerful grounds for urging a course correction sooner rather than
later, on three main grounds: to eliminate the risk of a catastrophic fiscal
collapse, achieve the advantages of tax smoothing, and smooth adjustments to the
consumption made possible by various government outlays. Political economy
considerations suggest that the risk of a catastrophic fiscal collapse may be
significant even though in principle it could easily be avoided.Danial Shaviro, "The Long-Term
Fiscal Gap: Is the Main Problem Generational Inequity?" ---
Click Here
Also see Paul Caron's blog from the NYU Law School on January 15, 2009 ---
Click Here

As we've documented the myriad ways
that Washington encouraged the housing bubble, the media and Democrats continue
to search for evidence to blame it all on "deregulation." One alleged
perpetrator, the
Gramm-Leach-Bliley Act, was released without charges after the record
revealed that Joe Biden voted for it and Bill Clinton signed it. More to the
point, investment banks were already free, prior to the 1999 law, to invest in
the same assets that have wreaked such havoc today. Editors of The Wall Street Journal, October 18, 2008 ---
http://online.wsj.com/article/SB122428201410246019.html?mod=djemEditorialPage

A second paper in this series will examine the
theoretical justifications for the importance of the stock market as perhaps the
central financial institution in the United States.
"Who Needs the Stock Market? Part I: The Empirical
Evidence," by Lawrence E. Mitchell George Washington University - Law School,
SSRN, October 30, 2008 ---
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1292403

Data on historical and current
corporate finance trends drawn from a variety of sources present a
paradox. External equity has never played a significant role in
financing industrial enterprises in the United States. The only American
industry that has relied heavily upon external financing is the finance
industry itself. Yet it is commonly accepted among legal scholars and
economists that the stock market plays a valuable role in American
economic life, and a recent, large body of macroeconomic work on
economic development links the growth of financial institutions
(including, in the U.S, the stock market) to growth in real economic
output. How can this be the case if external equity as represented by
the stock market plays an insignificant role in financing productivity?
This paradox has been largely ignored in the legal and economic
literature.

This paper surveys the history of
American corporate finance, presents original and secondary data
demonstrating the paradox, and raises questions regarding the structure
of American capital markets, the appropriate rights of stockholders, the
desirable regulatory structure (whether the stock market should be
regulated by the Securities and Exchange Commission or the Commodities
Futures Trading Commission, for example), and the overall relationship
between finance and growth.

The answers to these questions are
particularly pressing in light of a dramatic increase in stock market
volatility since the turn of the century creating distorted incentives
for long-term corporate management, especially trenchant in light of the
recent global financial collapse.

A second paper in this series will
examine the theoretical justifications for the importance of the stock
market as perhaps the central financial institution in the United
States.

Few forecast these (2008 economic meltdown) events; although, in an outbreak of retrospective
foresight, an increasing number now claim they saw it coming. The reality is
that among all the banks, investors, academics and policy-makers, only a handful
were able to identify ahead of time the causes and potential scale of the
crisis. (The Handful were - Bill White, formerly of both the Bank of Canada and
the Bank for International Settlements; Harvard University’s Ken Rogoff; Nouriel
Roubini of New York University; Wynne Godley of Cambridge; and Bernard Connolly
of AIG Financial Products). I came acrossthis paperby Caludio Borio of BIS.Amol Agrawal, Mostly Economics Blog, December
19, 2008 ---
http://mostlyeconomics.wordpress.com/
Jensen CommentHindsight: This 2006 video makes fools out of
Ben Stein and Art Laffer and makes a hero out of Peter Schiff.To this I might add Peter Schiff. Arthur Laffer's
preditions in 2006 predictions became a sick joke. Also you
Ben Stein
lovers may have second thoughts watching him proclaim, in 2006, that the
subprime problem is going to be a "tiny" problem. Watch Peter Schiff
make fools out of
Art Laffer,
Ben Stein, and other finance “experts” in this video. Watch Ben Stein recommend that you invest heavily in Merrill
Lynch before its shares tanked. Some of these popular media "experts" need to
spend more time studying and reading and less time broadcasting
poorly-researched advice to investors. Peter Schiff, on the other hand, does his
homework. This video is really revealing about the advice we get on television.
The video is available at the Financial Rounds Blog,
November 18 at
http://financeprofessorblog.blogspot.com/2008/11/peter-schiff-prophet-from-past.htmlUpdate on the bet Art Laffer made with Peter Schiff ---
Listen to Laffer try to weasel out of paying up ---
http://www.youtube.com/watch?v=z3WjgKUf-kA

Introductory Comment
Henry Paulson knows his $700 billion (read that $1 trillion) bailout plan is not
going to save the banks that are now submerged in nearly-worthless mortgaged
investments. I think Jonathon Weil (see Appendix
G) hit the nail on the head as to why Paulson chose this particular
bailout proposal. Paulson is really buying time while leaders in Congress dine
on crow instead of lobster. Read this as meaning that Paulson is saving us from
runaway populism al Barney Frank and Chris Dodd. But Paulson cannot save the
banks that are truly submerged. Read the following in Appendix G.

The plan goes like this: Treasury will pay
financial institutions above-market prices for garbage assets nobody else
wants. Then, through the magic of mark-to-Paulson accounting, everybody else
that owns similar stuff will use those same prices, or marks, to value the
trash on their own balance sheets.

Shazam! Banks and insurance companies write up the
asset values on their books. They post big profits. Their capital goes up.
Everyone gets fooled. And nobody knows the difference.

Except, we do. And that's why the plan
probably won't work.

Still, give Paulson and Federal Reserve Chairman
Ben Bernanke credit for ingenuity. At the same time banks are begging
regulators to suspend mark-to-market accounting rules so they can avoid
disclosing more losses, Paulson and Bernanke instead devise a way to abuse
the same rules for the same banks' benefit.

Jensen Comment
But most bankrupted banks will stay in business. Some will be bought out at
bargain basement prices by stronger banks. Some will simply have new owners.
The original owners (shareholders) will suck gas in either of these two
outcomes.

November 12, 2008 Update:
Paulson finally came to his senses and opted for direct investment in banks
via loans and equity rather than buying up all the junk mortgages owned by
troubled banks.

A more palatable approach would
be for the government to drive a Warren Buffett style hard bargain, in which,
rather than buying anything from banks, the government would invest in them in a
form, such as purchase of newly issued preferred stock, or bonds with a long
maturity, that would augment the banks' capital and thus enable banks to make
more loans. That would avoid conferring a windfall on the banks by overpaying
them for their bad securities; no one thinks Buffett is conferring a windfall on
Goldman Sachs. After the industry was back on its feet, the government could
sell the bank stocks or bonds that it had acquired. Richard Posner, "The $700+ Billion Bailout," The Becker-Posner Blog,
September 28, 2008 ---
http://www.becker-posner-blog.com/

Finally, the "too big to fail"
approach to banks and other companies should be abandoned as new long-term
financial policies are developed. Such an approach is inconsistent with a free
market economy. It also has caused dubious company bailouts in the past, such as
the large government loan years ago to Chrysler, a company that remained weak
and should have been allowed to go into bankruptcy. All the American auto
companies are now asking for handouts too since they cannot compete against
Japanese, Korean, and German carmakers. They will probably get these subsidies,
even though these American companies have been badly managed. A "too many to
fail" principle, as in the present financial crisis, may still be necessary on
hopefully rare occasions, but failure of badly run big financial and other
companies is healthy and indeed necessary for the survival of a robust free
enterprise competitive system.Nobel Laureate Gary Becker, "The $700+ Billion Bailout," The
Becker-Posner Blog, September 28, 2008 ---
http://www.becker-posner-blog.com/

What will happen to some of the banks that are submerged
in bad debts?Hundreds of banks
will have three options if they are not transfused with bailout billions:

They can (or will be forced
to) close their doors. This will rarely happen except in the case of a few
remote banks among Sarah Palin’s constituency.

They will sell out at
bargain-basement prices to stronger banks. To date the largest (record
holder) of the banks infested with trash mortgage securities is the WaMu
system of banks that sold really cheap to JP Morgan. Wachovia may become a
new record breaker in this department. The badly injured parties in these
deals are shareholders that get wiped out, which translates in some respects
to wounded mutual funds and pension funds. CREF is so big and so diversified
that losses on Wachovia probably won’t be felt much in your eventual
retirement checks. You should worry more about what the $55+ trillion in the
Federal Government’s liabilities will do to your future ---
http://www.trinity.edu/rjensen/2008Bailout.htm#NationalDebt

They can continue to
operate in bankruptcy and screw their shareholders and creditors. Then they
can get shareholders who will be buying into pretty good deals or they won’t
buy in to save the bankrupted banks.

Keep in mind
that none of the above outcomes will damage depositors unless they had
account balances above $100,000. Those depositors will be paid off when
Congress makes it $56+ trillion or more. See Appendix A
Actually the best solution, in my opinion, is not bail the banks out with
billions. Read about the best options in the following article:“Bridge Loan to Nowhere,” by Thomas Ferguson & Robert
Johnson, The Nation, September 22, 2008 ---
http://www.thenation.com/doc/20081006/ferguson_johnson

Everett Dirksen,
as Minority Senate Leader beginning in 1959, is most widely noted for a
quotation that he never made in these exact words: "A billion here, a billion
there, pretty soon, you're talking real money". What he really meant to say was
"A trillion here and a trillion there means you can't possibly be talking about
real money."

The National Debt
Clock ---
http://www.brillig.com/debt_clock/
At the above site it appears to be a fixed number.
But now hit your refresh button to see how much it's changed in just a few
seconds.
At 9:34 a.m. on September 23, 2008 it was $9,734,361,140,920.08 trillion
At 9:35 a.m. on September 23, 2008 it was $9,734,365,595,383.82 trillionWhat was added in that minute was mostly added to pay the interest on the
National Debt.
The annual amount of interest per year on the above number at 6% is
$584,061,935,723.03 billionThis translates to well over a million dollars a minute,
most of which is funded by adding to the National Debt.
There's noreal money
here since the U.S. Government never intends to pay off the National Debt,
not one farthing.
There's a greatly increased chance in 2008 that U.S. debt will receive a lowered
credit rating, which will greatly increase the cost of out national debt each
minute.

But the National
Debt is only the amount we have actually borrowed on notes because the U.S.
needed cash to pay current bills due. Every accountant knows that the unbooked
liabilities can be much, much larger because we've not yet needed to currently
borrow the money to pay bills that are coming in to us or our grandchildren in
the future.

Because U.S.
Government accounting is in such chaos (the GAO will not even sign off on its
annual audits of the Pentagon), nobody on earth really knows what our total
liabilities are. The former top accountant in the Federal government estimates
that the total is well in excess of $55+ trillion (present value discounted)
before the 2008 deficit is factored in.

It really doesn't matter since the present $55+ trillion U.S. Government
mortgage is really a problem passed on to our unborn grandchildren who, by 2050,
will be street beggars in Brazil, China, India, and Russia ---
http://www.trinity.edu/rjensen/entitlements.htm

Their report, "Dreaming with BRICs: The Path to
2050," predicted that within 40 years, the economies of Brazil, Russia,
India and China - the BRICs - would be larger than the US, Germany, Japan,
Britain, France and Italy combined. China would overtake the US as the
world's largest economy and India would be third, outpacing all other
industrialised nations.
"Out of the shadows," Sydney Morning Herald, February 5, 2005 ---
http://www.smh.com.au/text/articles/2005/02/04/1107476799248.html

In the end, Mr. Bush’s appearance
(address to the nation urging an added $700 billion to bailout the bankers)
was just another reminder of something that has been worrying us throughout this
crisis: the absence of any real national leadership, including on the campaign
trail. Given Mr. Bush’s shockingly weak performance, the only ones who could
provide that are the two men battling to succeed him. So far, neither John
McCain nor Barack Obama is offering that leadership. What makes it especially
frustrating is that this crisis should provide each man a chance to explain his
economic policies and offer a concrete solution to the current crisis. Editorial,The New York Times,
September 25, 2008 ---
http://www.nytimes.com/2008/09/25/opinion/25thu1.html?_r=1&oref=slogin

"Pittsburgh Public Schools officials say they want to
give struggling children a chance, but the district is raising eyebrows with a
policy that sets 50 percent as the minimum score a student can receive for
assignments, tests and other work," reports the Pittsburgh Post-Gazette . . . Of
course, there's an obvious (better) solution
to this: Make the minimum score 100% instead of 50%. That ensures that
Pittsburgh students will have the highest grades in the country (as long as no
other school district learns the secret), and also that there will be no
awkwardness, since no one will know any math.
"Eyebrows raised over city school policy that sets 50% as minimum
score: 1+1=3? In city schools, it's half right," Pittsburgh Post-Gazette,
September 22, 2008 ---
http://www.post-gazette.com/pg/08266/914029-298.stm
Jensen CommentActually
the Pittsburgh schools learned about the 10% Rule in Texas and decided to one-up
the Lone Star State with a 50% Rule. This gave
Hank Paulson
an idea. What if a homeowner made no payments on a sub-prime mortgage? Why not
give 50% minimum credit for each non-payment to lower the amount owed.? That way
the bailout recoveries won't look so bad since the government can thereby
receive half of what is owing to it with each bailed out mortgage. This will
appeal to Congress since there is public aversion to receiving zero on bailed
out mortgages. Yikes! I'm beginning to think like an accountant selling tax
shelters.

In a hearing today before the House Oversight
Committee, the credit rating agencies are being portrayed as
profit-hungry institutions that would give any deal their blessing for
the right price.

Case in point: this instant message exchange between two unidentified
Standard & Poor's officials about a mortgage-backed security deal on
4/5/2007:

Official #1: Btw (by the way) that deal is ridiculous.

Official #2: I know right...model def (definitely) does not capture half
the risk.

Official #1: We should not be rating it.

Official #2: We rate every deal. It could be structured by cows and we
would rate it.

A former executive of Moody's says
conflicts of interest got in the way of rating agencies properly valuing
mortgage backed securities.

Former Managing Director Jerome Fons, who worked at Moody's until August
of 2007, says Moody's was focused on "maxmizing revenues," leading it to
make the firm more "issuer friendly."

The three firms that dominate the $5 billion-a-year
credit rating industry - Standard & Poor's, Moody's Investors Service and Fitch
Ratings - have been faulted for failing to identify risks in subprime mortgage
investments, whose collapse helped set off the global financial crisis. The
rating agencies had to downgrade thousands of securities backed by mortgages as
home-loan delinquencies have soared and the value of those investments
plummeted. The downgrades have contributed to hundreds of billions in losses and
writedowns at major banks and investment firms. The agencies are crucial
financial gatekeepers, issuing ratings on the creditworthiness of public
companies and securities. Their grades can be key factors in determining a
company's ability to raise or borrow money, and at what cost which securities
will be purchased by banks, mutual funds, state pension funds or local
governments. A yearlong review by the SEC, which issued the results last summer,
found that the three big (credit rating) agencies failed to rein in conflicts of
interest in giving high ratings to risky securities backed by subprime
mortgages.
"SEC Puts Off Vote on Rules for Rating Agencies," AccountingWeb, November
19, 2008 ---
http://accounting.smartpros.com/x63855.xml
Jensen Comment
It’s beginning to look like Wall Street is rearing up once again to prevent the
SEC from imposing reforms on credit rating agencies. In spite of the crisis, it
will once again be business as usual with the credit rating agencies having
conflicts of interest not in the interest of investors.
Bob Jensen's threads on historic abuses by credit rating agencies are at
http://www.trinity.edu/rjensen/FraudRotten.htm#CreditRatingAgencies

More than 150 U.S. economists, including three
Nobel Prize winners, urged Congress to hold off on passing a $700 billion
financial market rescue plan until it can be studied more closely.

In a Sept. 24 letter to Congressional leaders, 166
academic economists said they oppose Treasury Secretary Henry Paulson's plan
because it's a ``subsidy'' for business, it's ambiguous and it may have
adverse market consequences in the long term. They also expressed alarm at
the haste of lawmakers and the Bush administration to pass legislation.

``It doesn't seem to me that a lot decisions that
we're going to have to live with for a long time have to be made by
Friday,'' said Robert Lucas, a University of Chicago economist and 1995
Nobel Prize winner who signed the letter. ``The situation may get urgent,
but it's not urgent right now. Right now it's a financial sector problem.''

The economists who signed the letter represent
various disciplines, including macroeconomics, microeconomics, behavioral
and information economics, and game theory. They also span the political
spectrum, from liberal to conservative to libertarian.

On October 3, 2005 Bush signed the $700 billion bankers' bailout bill, with half the money subject to a
Congressional veto, Congressional aides said. Under the plan, the Treasury
secretary receives $250 billion immediately and could have an additional $100
billion if he certifies it is also needed. What do you think the chances are
that he’ll eventually say: “Nah, that first $250 billion is more than enough?”

What if you were buying an albino horse for your kid that had a Bush Stables
sticker price of $7,000? You offer $2,500 plus another $1,000 if Hi Ho Silver
lasts for more than a month.

Instantly the Masked Man whips out the contract and says “sign here." He
hurriedly scoops up the $2,500 and races out the door while the heavens are
playing the William Tell Overture ---
http://hk.youtube.com/watch?v=krKTMKnTGsE

With such an eager
horse trader aren’t you the least bit suspicious about that original $700
billion sticker price?

Of course there is that added $350 billion kicker that Congress might
additionally offer if and only if the first $350 billion is doing such a good
job. I think we should spend another $350 billion only if the first $350 billion
is doing a rotten job keeping us out a deep economic depression.

Sarah Palin was utterly naive when becoming a vice presidential candidate.
She believed that meaningful Congressional reforms were actually possible. She
did not truly understand how House Speaker Pelosi controls Congressional voting
by doling out
earmarked corruption and, now, bailout corruption. An even worse problem
with Palin is that, yikes, she wants to balance the Federal Budget. I mean how
naive can can the a hockey mom be?

In reality the added $350 billion option is for any remaining bad car and
motorcycle loans held by local banks, some
pork for
Byrd’s nests in West
Virginia, and millions of new seeds for Barney Frank's
Acorn farm. To avoid a
Congressional veto, Nancy Pelosi gets a new Airbus to fly
nonstop back and forth to San Francisco for the next eight years, and Sarah Palin gets a saddle for a snow goose on her return flight to Alaska. Because she
has such large glasses, there’s no need for a goggles in Palin’s courtesy
appropriation.

This time of year it’s growing very cold when riding a snow goose near the
arctic. There’s a good possibility that Pelosi will instead drop Palin off in
Fairbanks if the hockey mom political reformer promises to never leave Alaska henceforth and
forevermore. At this point Pelosi’s offer looks like the best option available
to Gov. Palin. Alaska’s Governor might even bag a moose or two while the Airbus
is on its landing approach. There's precedent here. Nancy Pelosi booted reformer
Jeff Flake
of the House Judiciary Committee because he's repeatedly tried to end earmark
fraud in Congress. Sorry Jeff! No free ride for lowlifes on the Speaker's
Airbus.

But why should we worry? The two presidential candidates are offering tax
reductions rather than increases, so even if the ultimate cost of the bailout is
$5 trillion that’s just a trifle in annual interest to add tothe million+
dollars a minute taxpayers are already paying in interest on the present
National Debt. It’s a relief now that Bank America will get a bailout
appropriation of $200 billion to cover the fraud losses on its wholly owned
Subsidiary, Countrywide Financial. Countrywide can once again offer you a sweet
sub-prime mortgage and extend your credit card limit to $5 million. The United
States is back in the credit
pyramid
business.

This trillion dollar (probably) bailout proposal before
Congress is beginning to smell
like the bottom of a lobster boat. The trouble is that both Democrats and
Republicans love to dine on lobster dinners paid for by their lobbyist friends.

Maybe the lobster analogy is even better than I thought since the Men in
Black (bankers) are now trying to get their claws into us on the way down --- sort of like
getting clawed by a big one before you can dump him in the pot.

I’m told that
bankers are now furiously combing the books to find out how many defaulted car
loans then can sell to the government.

But my hunch is that, in
relative proportions, the amount of the National Debt held by the Men in
Black on Wall Street is negligible. The Men in Black were heavy
speculators seeking higher commissions and higher returns that is paid out
on our National Debt.

Bankers (Men in Black) bet with their
bank's capital, not their own. If the bet goes right, they get a
huge bonus; if it misfires, that's the shareholders' problem.Sebastian Mallaby.
Council on Foreign Relations, as quoted by Avital Louria Hahn,
"Missing: How Poor Risk-Management Techniques Contributed to
the Subprime Mess," CFO
Magazine, March 2008, Page 53 ---
http://www.cfo.com/article.cfm/10755469/c_10788146?f=magazine_featured
Jensen Comment
Now that the Government is going to bail out these speculators with
taxpayer funds makes it all the worse. I received an email
message claiming that if you had purchased $1,000 of AIG
stock one year ago, you would have $42 left; with Lehman, you
would have $6.60 left; with Fannie or Freddie, you would have
less than $5 left. But if you had purchased $1,000 worth of beer
one year ago, drank all of the beer, then turned in the cans for
the aluminum recycling REFUND, you would have had $214. Based on
the above, the best current investment advice is to drink
heavily and recycle. It's called the 401-Keg. Why let others
gamble your money away when you can piss it away on your own?

Jensen Comment
Michael Burry is the physician who anticipated the subprime scandal and made a
fortune on short positions.

PwC's Appeal to Upgrade the Shameful Valuation Profession Smitten With
Non-independence and Unreliability

Jensen Comment
Tom Selling repeatedly assumes there is a valuation profession of men and women
in white robes and gold halos who can be called upon to reliably and
independently valuate such things as troubled loan investments having no deep
markets. Bob Jensen argues that the valuation profession is one of the
least-independent and least-reliable professions in the world, especially in the
USA as evidenced in part by the shameful valuations of mortgage collateral on
tens of millions of properties, thereby enabling subprime mortgages that never
should have been granted in the first place. Furthermore credit rating agencies
that value securities participated wildly in overvaluing poisoned CDO bonds that
brought down some of the big investment banks of Wall Street like Bear Sterns,
Merrill Lynch, and Lehman Bros.

In the article below, PwC calls the valuation profession shameful and calls
for major upgrades that, while falling short of issuing white robes with gold
halos, would go a long way toward improving a rotten profession.

The largely unregulated valuation profession could
use a shake-up, in the view of some who rely on valuations to achieve
regulatory compliance.

PwC recently published two white papers calling on
the valuation profession to up their game in terms of unifying themselves
under a single professional framework and improving their standards. The
financial reporting world needs greater quality and consistency, the Big 4
firms says, as financial reporting grows increasingly reliant on valuations
to help prepare and audit financial statements steeped in fair value
measurements. One paper focuses on the need for the valuation profession to
unify itself under a single professional infrastructure, while the other
addresses the need for better valuation standards.

The message is consistent with one delivered
earlier by Paul Beswick, now chief accountant at the Securities and Exchange
Commission. “The fragmented nature of the profession creates an environment
where expectation gaps can exist between valuators, management, and
auditors, as well as standard setters and regulators,” he said at a 2011
accounting conference. The SEC and the Public Company Accounting Oversight
Board both have called on preparers and auditors to pay closer attention to
the valuations they are relying on and not simply accept them at face value.

“Historically, the valuation profession hasn't been
front and center in capital markets,” says John Glynn, U.S. valuation
services leader for PwC. “The accounting model didn't have as many pieces
measured at fair value as we have today. Some of the questions about the
professional infrastructure that didn't matter previously have become more
apparent.”

The valuation profession is governed by a number of
different professional organizations, PwC says, each with different
credentialing and membership requirements and none of them specific to the
needs of capital markets. “To maintain its professional standing in an
increasingly rigorous environment and promote greater confidence in its
work, the valuation profession needs to address questions about the quality,
consistency, and reliability of its valuations, particularly those performed
for financial reporting purposes,” PwC writes. “A key element to
successfully addressing such questions is having a leading global standard
setter that issues technical valuation standards governing the performance
of valuations for financial reporting purposes.”

The answer is not necessarily a new regulatory
channel, says Glynn. “We need to give the valuation profession a way to
build a self-regulatory mechanism,” he says. “One or or more of the
professional organizations need to agree to build something that is focused
on building a high-quality infrastructure to support the valuation
professionals that are working in public capital markets, particularly
around financial reporting.” That should include education requirements,
accreditations, certifications, as well as professional standards and
performance standards developed under a robust system of due process, he
says. The International Valuations Standards Council is showing potential to
become a leader in driving the profession to a unified, global valuation
approach, Glynn says.

Three former IndyMac Bancorp Inc. executives must
pay $169 million in damages to federal regulators for making negligent loans
to homebuilders as the real estate market was deteriorating, a jury decided.

The federal court jury in Los Angeles issued the
verdict against Scott Van Dellen, the former chief executive officer of
IndyMac’s Homebuilder Division; Richard Koon, the unit’s former chief
lending officer; and Kenneth Shellem, the former chief credit officer.
Jurors yesterday found them liable for negligence and breach of fiduciary
duty.

The jury awarded the damages to the Federal Deposit
Insurance Corp., which brought the lawsuit in 2010.

The FDIC, which took over the failed subprime
mortgage lender in 2008, alleged the men caused $500 million in losses at
the homebuilders unit by continuing to push for growth in loan production
without regard for credit quality and despite being aware a downturn in the
real estate market was imminent.

The agency said the executives made loans to
homebuilders that weren’t creditworthy or didn’t provide sufficient
collateral.

“Today’s verdict is the result of a deliberate
effort by the government to scapegoat a few men for the impact that the
unforeseen and unprecedented housing collapse in 2007 had at IndyMac,” Kirby
Behre, a lawyer for Shellem and Koon, said in an e-mailed statement after
yesterday’s verdict.

“Mr. Shellem and Mr. Koon used the utmost care in
making loan decisions, and there is no doubt that all of the loans at issue
would have been repaid except for the housing crash,” Behre said.

Robert Corbin, a lawyer for Van Dellen, didn’t
immediately return a call to his office yesterday after regular business
hours seeking comment on the verdict.

The verdict was reported earlier by the Los Angeles
Daily Journal.

The case is FDIC v. Van Dellen, 10-04915, U.S.
District Court, Central District of California (Los Angeles).

We argue that the vast bulk of movements in
aggregate real economic activity during the Great Recession were due to
financial frictions interacting with the zero lower bound. We reach this
conclusion looking through the lens of a New Keynesian model in which
firms face moderate degrees of price rigidities and no nominal
rigidities in the wage setting process. Our model does a good job of
accounting for the joint
behavior of labor and goods markets, as well as inflation, during the
Great Recession. According to the model the observed fall in total
factor productivity and the rise in the cost of working capital played
critical roles in accounting
for the small size of the drop in inflation that occurred during the
Great Recession.

An Excellent Presentation on the Flaws of Finance, Particularly the Flaws
of Financial Theorists

A recent topic on the AECM listserv concerns the limitations of accounting
standard setters and researchers when it comes to understanding investors. One
point that was not raised in the thread to date is that a lot can be learned
about investors from the top financial analysts of the world --- their writings
and their conferences.

The only group of people who view the world realistically are the
clinically depressed.

Model builders should stop substituting
elegance for reality.

All financial theorists should be forced to
interact with practitioners.

Practitioners need to abandon the myth of optimality before the fact.
Jensen Note
This also applies to abandoning the myth that we can set optimal accounting
standards.

In the long term fundamentals matter.

Don't get too bogged down in details at the expense of the big picture.

Max Plank said science advances one funeral at a time.

The speaker then entertains questions from the audience (some are very
good).

James Montier is a very good speaker from England!

Mr. Montier is a member of GMO’s asset allocation
team. Prior to joining GMO in 2009, he was co-head of Global Strategy at
Société Générale. Mr. Montier is the author of several books including
Behavioural Investing: A Practitioner’s Guide to Applying Behavioural
Finance; Value Investing: Tools and Techniques for Intelligent Investment;
and The Little Book of Behavioural Investing. Mr. Montier is a visiting
fellow at the University of Durham and a fellow of the Royal Society of
Arts. He holds a B.A. in Economics from Portsmouth University and an M.Sc.
in Economics from Warwick University
http://www.gmo.com/america/about/people/_departments/assetallocation.htm

There's a lot of useful information in this talk for accountics scientists.

In March, Duffie and the Squam Lake Group proposed
a dramatic new restriction on executive pay at “systemically important”
financial institutions. Duffie argues that top bank executives still have
lopsided incentives to take excessive risks. The proposal: Force them to
defer 20 percent of their pay for five years, and to forfeit that money
entirely if the bank’s capital sinks to unspecified but worrisome levels
before the five years is up.

“On most issues,” Duffie said, “the banks would be
glad to see me go away.”

Jensen Comment
Squam Lake and its 30 islands is in the Lakes Region of New Hampshire ---
http://en.wikipedia.org/wiki/Squam_Lake
It is better known as "Golden Pond" after Jane Fonda, her father (Henry) and
Katherine Hepburn appeared in the Academy Award winning movie called "On
Golden Pond" that was filmed on Squam Lake. Professor Duffie now has some
"golden ideas" for finance reforms.

Sherry Hunt never expected to be a senior manager
at a Wall Street bank. She was a country girl, raised in rural Michigan by a
dad who taught her to fish and a mom who showed her how to find wild
mushrooms. She listened to Marty Robbins and Buck Owens on the radio and
came to believe that God has a bigger plan, that everything happens for a
reason.

She got married at 16 and didn’t go to college.
After she had her first child at 17, she needed a job. A friend helped her
find one in 1975, processing home loans at a small bank in Alaska. Over the
next 30 years, Hunt moved up the ladder to mortgage-banking positions in
Indiana, Minnesota and Missouri, Bloomberg Markets magazine reports in its
July issue.

On her days off, when she wasn’t fishing with her
husband, Jonathan, she rode her horse, Cody, in Wild West shows. She
sometimes dressed up as the legendary cowgirl Annie Oakley, firing blanks
from a vintage rifle to entertain an audience. She liked the mortgage
business, liked that she was helping people buy houses.

In November 2004, Hunt, now 55, joined
Citigroup (C)Inc. as a vice president in the
mortgage unit. It looked like a great career move. The housing market was
booming, and the New York- based bank, the
sixth-largest lender in the U.S. at the time, was responsible for 3.5
percent of all home loans. Hunt supervised 65 mortgage underwriters at
CitiMortgage Inc.’s sprawling headquarters in O’Fallon, Missouri, 45 minutes
west of St. Louis.

Avoiding Fraud

Hunt’s team was responsible for protecting
Citigroup from fraud and bad investments. She and her colleagues inspected
loans Citi wanted to buy from outside brokers and lenders to see whether
they met the bank’s standards. The mortgages had to have properly signed
paperwork, verifiable borrower income and realistic appraisals.

Citi would vouch for the quality of these loans
when it sold them to investors or approved them for government mortgage
insurance.

Investor demand was so strong for mortgages
packaged into securities that Citigroup couldn’t process them fast enough.
The Citi stamp of approval told investors that the bank would stand behind
the mortgages if borrowers quit paying.

At the mortgage-processing factory in O’Fallon,
Hunt was working on an assembly line that helped inflate a housing bubble
whose implosion would shake the world. The O’Fallon mortgage machinery was
moving too fast to check every loan, Hunt says.

Phony Appraisals

By 2006, the bank was buying mortgages from outside
lenders with doctored tax forms, phony appraisals and missing signatures,
she says. It was Hunt’s job to identify these defects, and she did, in
regular reports to her bosses.

Executives buried her findings, Hunt says, before,
during and after the financial crisis, and even into 2012.

In March 2011, more than two years after Citigroup
took $45 billion in bailouts from the U.S. government and
billions more from the
Federal Reserve-- more in total than any other
U.S. bank-- Jeffery Polkinghorne, an O’Fallon
executive in charge of loan quality, asked Hunt and a colleague to stay in a
conference room after a meeting.

The encounter with Polkinghorne was brief and
tense, Hunt says. The number of loans classified as defective would have to
fall, he told them, or it would be “your asses on the line.”

Hunt says it was clear what Polkinghorne was asking
-- and she wanted no part of it.

‘I Wouldn’t Play Along’

“All a dishonest person had to do was change the
reports to make things look better than they were,” Hunt says. “I wouldn’t
play along.”

Instead, she took her employer to court -- and won.
In August 2011, five months after the meeting with Polkinghorne, Hunt sued
Citigroup in Manhattan federal court, accusing its home-loan division of
systematically violating U.S. mortgage regulations.

The U.S.
Justice Departmentdecided to join her suit in
January. Citigroup didn’t dispute any of Hunt’s facts; it didn’t mount a
defense in public or in court. On Feb. 15, 2012, the bank agreed to pay
$158.3 million to the U.S. government to settle the case.

‘Pure Myth’

Citigroup behaving badly as late as 2012 shows how
a big bank hasn’t yet absorbed the lessons of the credit crisis despite
billions of dollars in bailouts, says
Neil Barofsky, former special inspector general of
the Troubled Asset Relief Program.

“This case demonstrates that the notion that the
bailed-out banks have somehow found God and have reformed their ways in the
aftermath of the financial crisis is pure myth,” he says.

As a reward for blowing the whistle on her
employer, Hunt, the country girl turned banker, got $31 million out of the
settlement paid by Citigroup.

Hunt still remembers her first impressions of
CitiMortgage’s O’Fallon headquarters, a complex of three concrete-and-glass
buildings surrounded by manicured lawns and vast parking lots. Inside are
endless rows of cubicles where 3,800 employees trade e-mails and conduct
conference calls. Hunt says at first she felt like a mouse in a maze.

“You only see people’s faces when someone brings in
doughnuts and the smell gets them peeking over the tops of their cubicles,”
she says.

Jean Charities

Over time, she came to appreciate the camaraderie.
Every month, workers conducted the so-called Jean Charities. Employees
contributed $20 for the privilege of wearing jeans every day, with the money
going to local nonprofit organizations. With so many workers, it added up to
$25,000 a month.

“Citi is full of wonderful people, conscientious
people,” Hunt says.

Those people worked on different teams to process
mortgages, all of them focused on keeping home loans moving through the
system. One team bought loans from brokers and other lenders. Another team,
called underwriters, made sure loan paperwork was complete and the mortgages
met the bank’s and the government’s guidelines.

Yet another group did spot-checks on loans already
purchased. It was such a high-volume business that one group’s assignment
was simply to keep loans moving on the assembly line.

Powerful Incentive

Still another unit sold loans to
Fannie Mae,
Freddie Macand Ginnie Mae, the
government-controlled companies that bundled them into securities for sale
to investors. Those were the types of securities that blew up in 2007,
igniting a global financial crisis.

Workers had a powerful incentive to push mortgages
through the process even if flaws were found: compensation. The pay of
CitiMortgage employees all the way up to the division’s chief executive
officer depended on a high percentage of approved loans, the government’s
complaint says.

By 2006, Hunt’s team was processing $50 billion in
loans that Citi-Mortgage bought from hundreds of mortgage companies. Because
her unit couldn’t possibly review them all, they checked a sample.

When a mortgage wasn’t up to federal standards --
which could be any error ranging from an unsigned document to a false income
statement or a hyped-up appraisal -- her team labeled the loan as defective.

Missing Documentation

In late 2007, Hunt’s group estimated that about 60
percent of the mortgages Citigroup was buying and selling were missing some
form of documentation. Hunt says she took her concerns to her boss, Richard
Bowen III.

Bowen, 64, is a religious man, a former Air Force
Reserve Officer Training Corps cadet at Texas Tech University in Lubbock
with an attention to detail that befits his background as a certified public
accountant. When he saw the magnitude of the mortgage defects, Bowen says he
prayed for guidance.

“The reason for this urgent e-mail concerns
breakdowns of internal controls and resulting significant but possibly
unrecognized financial losses existing within our organization,” Bowen
wrote. “We continue to be significantly out of compliance.”

No Change

There were no noticeable changes in the mortgage
machinery as a result of
Bowen’s warning, Hunt says.

Just a week after Bowen sent his e-mail, Sherry and
Jonathan were driving their Toyota Camry about 55 miles (89 kilometers) per
hour on four-lane Providence Road in Columbia, Missouri, when a
driver in a Honda Civic hit them head-on. Sherry broke a foot and her
sternum. Jonathan broke an arm and his sternum.

Doctors used four bones harvested from a cadaver
and titanium screws to stabilize his neck.

“You come out of an experience like that with a
commitment to making the most of the time you have and making the world a
better place,” Sherry says.

Three months after the accident, attorneys from
Paul, Weiss, Rifkind, Wharton & Garrison LLP, a
New York law firm representing Citigroup, interviewed Hunt. She had no idea
at the time that it was related to Bowen’s complaint, she says.

Home Computer

The lawyers’ questions made her search her memory
for details of loans and conversations with colleagues, she says. She
decided to take notes from that time forward on a spreadsheet she kept on
her home computer.

Bowen’s e-mail is now part of the archive of the
Financial Crisis Inquiry Commission, a panel created by Congress in 2009.
Citigroup’s response to the
commission, FCIC records show, came from
Brad Karp, chairman of
Paul Weiss.

He said Citigroup had reviewed Bowen’s issues,
fired a supervisor and changed its underwriting system, without providing
specifics.

Both the corporate CEO and the external auditing firm are to
explicitly sign off on the following and are subject (turns out to be a
ha, ha joke) to huge fines and jail time for egregious failure to do
so:

Assess both the design and operating
effectiveness of selected internal controls related to significant
accounts and relevant assertions, in the context of material
misstatement risks;

Understand the flow of transactions,
including IT aspects, in sufficient detail to identify points at
which a misstatement could arise;

Evaluate company-level (entity-level)
controls, which correspond to the components of the
COSO framework;

Rely on management's work based on factors
such as competency, objectivity, and risk;

Conclude on the adequacy of internal
control over financial reporting.

Most importantly as far as the CPA auditing firms are concerned is
that Sarbox gave those firms both a responsibility to verify that
internal controls were effective and the authority to charge more
(possibly twice as much) for each audit. Whereas in the 1990s auditing
was becoming less and less profitable, Sarbox made the auditing industry
quite prosperous after 2002.

There's a great gap between the theory of Sarbox and its enforcement

In theory, the U.S. Justice Department (including the FBI) is to enforce
the provisions of Section 404 and subject top corporate executives and audit
firm partners to huge fines (personal fines beyond corporate fines) and jail
time for signing off on Section 404 provisions that they know to be false.
But to date, there has not been one indictment in enormous frauds where the
Justice Department knows that executives signed off on Section 404 with
intentional lies.

In theory the SEC is to also enforce Section 404, but the SEC in Frank
Partnoy's words is toothless. The SEC cannot send anybody to jail. And the
SEC has established what seems to be a policy of fining white collar
criminals less than 20% of the haul, thereby making white collar crime
profitable even if you get caught. Thus, white collar criminals willingly
pay their SEC fines and ride off into the sunset with a life of luxury
awaiting.

And thus we come to the December 4 Sixty Minutes module that features
two of the most egregious failures to enforce Section 404:The astonishing case of CitiBank
The astonishing case of Countrywide (now part of Bank of America)

The Astonishing Case of CitiBank
What makes the Sixty Minutes show most interesting are the whistle
blowing revelations by a former Citi Vice President in Charge of Fraud
Investigations

What has to make the CitiBank revelations the most embarrassing
revelations on the Sixty Minutes blockbuster emphasis that top
CItiBank executives were not only informed by a Vice President in Charge of
Fraud Investigation of huge internal control inadequacies, the outside U.S.
government top accountant, the U.S. Comptroller General, sent an official
letter to CitiBank executives notifying them of their Section 404 internal
control failures.

What the Sixty Minutes show failed to mention is that the
external auditing firm of KPMG also flipped a bird at the U.S. Comptroller
General and signed off on the adequacy of its client's internal controls.

A few months thereafter CitiBank begged for and got hundreds of billions
in bailout money from the U.S. Government to say afloat.

The implication is that CitiBank and the other Wall Street corporations
are just to0 big to prosecute by the Justice Department. The Justice
Department official interviewed on the Sixty Minutes show sounded
like hollow brass wimpy taking hands off orders from higher authorities in
the Justice Department.

The SEC worked out a settlement with CitiBank, but the fine is such a
joke that the judge in the case has to date refused to accept the
settlement. This is so typical of SEC hand slapping settlements --- and the
hand slaps are with a feather.

The astonishing case of Countrywide (now part of Bank of America)

Countrywide Financial before 2007 was the largest issuer of mortgages on
Main Streets throughout the nation and by estimates of one of its own
whistle blowing executives in charge of internal fraud investigations over
60% of those mortgages were fraudulent.

After Bank of America purchased the bankrupt Countrywide, BofA top
executives tried to buy off the Countrywide executive in charge of fraud
investigations to keep him from testifying. When he refused BofA fired him.

Whereas the Justice Department has not even attempted to indict
Countrywide executives and the Countrywide auditing firm of Grant Thornton
(later replaced by KPMG) to bring indictments for Section 404 violations,
the FTC did work out an absurdly low settlement of $108 million for 450,000
borrowers paying "excessive fees" and the attorneys for those borrowers ---
http://www.nytimes.com/2011/07/21/business/countrywide-to-pay-borrowers-108-million-in-settlement.html
This had nothing to do with the massive mortgage frauds committed by
Countrywide.

Former Countrywide CEO Angelo Mozilo settled the SEC’s Largest-Ever
Financial Penalty ($22.5 million) Against a Public Company's Senior
Executive
http://sec.gov/news/press/2010/2010-197.htm
The CBS Sixty Minutes show estimated that this is less than 20% of what he
stole and leaves us with the impression that Mozilo deserves jail time but
will probably never be charged by the Justice Department.

I was disappointed in the CBS Sixty Minutes show in that it completely
ignored the complicity of the auditing firms to sign off on the Section 404
violations of the big Wall Street banks and other huge banks that failed.
Washington Mutual was the largest bank in the world to ever go bankrupt. Its
auditor, Deloitte, settled with the SEC for Washington Mutual for
$18.5 million. This isn't even a hand slap relative to the billions lost by
WaMu's investors and creditors.

No jail time is expected for any partners of the negligent auditing firms.
.KPMG settled for peanuts with Countrywide for
$24 million of negligence and New Century for
$45 million of negligence costing investors billions.

There is no mystery where the Occupy Wall Street
movement came from: It is an offspring of the same false narrative about the
causes of the financial crisis that exculpated the government and brought us
the Dodd-Frank Act. According to this story, the financial crisis and
ensuing deep recession was caused by a reckless private sector driven by
greed and insufficiently regulated. It is no wonder that people who hear
this tale repeated endlessly in the media turn on Wall Street to express
their frustration with the current conditions in the economy.

Their anger should be directed at those who
developed and supported the federal government's housing policies that were
responsible for the financial crisis.

Beginning in 1992, the government required Fannie
Mae and Freddie Mac to direct a substantial portion of their mortgage
financing to borrowers who were at or below the median income in their
communities. The original legislative quota was 30%. But the Department of
Housing and Urban Development was given authority to adjust it, and through
the Bill Clinton and George W. Bush administrations HUD raised the quota to
50% by 2000 and 55% by 2007.

It is certainly possible to find prime borrowers
among people with incomes below the median. But when more than half of the
mortgages Fannie and Freddie were required to buy were required to have that
characteristic, these two government-sponsored enterprises had to
significantly reduce their underwriting standards.

Fannie and Freddie were not the only
government-backed or government-controlled organizations that were enlisted
in this process. The Federal Housing Administration was competing with
Fannie and Freddie for the same mortgages. And thanks to rules adopted in
1995 under the Community Reinvestment Act, regulated banks as well as
savings and loan associations had to make a certain number of loans to
borrowers who were at or below 80% of the median income in the areas they
served.

Research by Edward Pinto, a former chief credit
officer of Fannie Mae (now a colleague of mine at the American Enterprise
Institute) has shown that 27 million loans—half of all mortgages in the
U.S.—were subprime or otherwise weak by 2008. That is, the loans were made
to borrowers with blemished credit, or were loans with no or low down
payments, no documentation, or required only interest payments.

Of these, over 70% were held or guaranteed by
Fannie and Freddie or some other government agency or government-regulated
institution. Thus it is clear where the demand for these deficient mortgages
came from.

The huge government investment in subprime
mortgages achieved its purpose. Home ownership in the U.S. increased to 69%
from 65% (where it had been for 30 years). But it also led to the biggest
housing bubble in American history. This bubble, which lasted from 1997 to
2007, also created a huge private market for mortgage-backed securities (MBS)
based on pools of subprime loans.

As housing bubbles grow, rising prices suppress
delinquencies and defaults. People who could not meet their mortgage
obligations could refinance or sell, because their houses were now worth
more.

Accordingly, by the mid-2000s, investors had begun
to notice that securities based on subprime mortgages were producing the
high yields, but not showing the large number of defaults, that are usually
associated with subprime loans. This triggered strong investor demand for
these securities, causing the growth of the first significant private market
for MBS based on subprime and other risky mortgages.

By 2008, Mr. Pinto has shown, this market consisted
of about 7.8 million subprime loans, somewhat less than one-third of the 27
million that were then outstanding. The private financial sector must
certainly share some blame for the financial crisis, but it cannot fairly be
accused of causing that crisis when only a small minority of subprime and
other risky mortgages outstanding in 2008 were the result of that private
activity.

When the bubble deflated in 2007, an unprecedented
number of weak mortgages went into default, driving down housing prices
throughout the U.S. and throwing Fannie and Freddie into insolvency. Seeing
these sudden losses, investors fled from the market for privately issued MBS,
and mark-to-market accounting required banks and others to write down the
value of their mortgage-backed assets to the distress levels in a market
that now had few buyers. This raised questions about the solvency and
liquidity of the largest financial institutions and began a period of great
investor anxiety.

The government's rescue of Bear Stearns in March
2008 temporarily calmed the market. But it created significant moral hazard:
Market participants were led to believe that the government would rescue all
large financial institutions. When Lehman Brothers was allowed to fail in
September, investors panicked. They withdrew their funds from the
institutions that held large amounts of privately issued MBS, causing banks
and others—such as investment banks, finance companies and insurers—to hoard
cash against the risk of further withdrawals. Their refusal to lend to one
another in these conditions froze credit markets, bringing on what we now
call the financial crisis.

EconomicsCorporate Governance Failures: The Role of Institutional Investors
in the Global Financial Crisis edited by James P. Hawley, Shyam J.
Kamath, and Andrew T. Williams (University of Pennsylvania Press; 344 pages;
$69.95). Writings on such topics as the limits of corporate governance in
dealing with asset bubbles.

From Financial Crisis to Global Recovery by Padma Desai
(Columbia University Press; 254 pages; $27.50). Considers the origins of the
contemporary crisis and the prospects for recovery; includes comparative
discussion of the Great Depression.

The 2008 financial crisis happened because no one
prevented it. Those who might have stopped it didn't. They are to blame.

Greedy bankers, incompetent managers and
inattentive regulators created the greatest financial breakdown in nearly a
century. Doesn't that make you feel better? After all, how likely is it that
some human beings will be greedy at exactly the same time others are
incompetent and still others are inattentive?

Oh wait.

You could almost defend the Financial Crisis
Inquiry Commission's (FCIC) new report if the question had been who, in
hindsight, might have prevented the crisis. Alas, the answer is always going
to be the Fed, which has the power to stop just about any macro trend in the
financial markets if it really wants to. But the commission was asked to
explain why the bubble happened. In that sense, its report doesn't seem even
to know what a proper answer might look like, as if presented with the
question "What is 2 + 2?" and responding "Toledo" or "feral cat."

The dissenters at least propose answers that might
be answers. Peter Wallison focuses on U.S. housing policy, a diagnosis that
has the advantage of being actionable.

The other dissent, by Keith Hennessey, Bill Thomas
and Douglas Holtz-Eakin, sees 10 causal factors, but emphasizes the
pan-global nature of the housing bubble, which it attributes to ungovernable
global capital flows.

That is also true, but less actionable.

Let's try our hand at an answer that, like Mr.
Wallison's, attempts to be useful.

The Fed will make errors. International capital
flows will sometimes be disruptive. Speculators will be attracted to hot
markets. Bubbles will be a feature of financial life: Building a bunch of
new houses is not necessarily a bad idea; only when too many others do the
same does it become a bad idea. On that point, not the least of the
commission's failings was its persistent mistaking of effects for causes,
such as when banks finally began treating their mortgage portfolios as hot
potatoes to be got rid of.

If all that can't be changed, what can? How about
the incentives that invited various parties to shovel capital into housing
without worrying about the consequences?

The central banks of China, Russia and various
Asian and Arab nations knew nothing about U.S. housing. They poured hundreds
of billions into it only because Fannie and Freddie were perceived as
federally guaranteed and paid a slightly higher yield than U.S. Treasury
bonds. (And one of the first U.S. actions in the crisis was to assure China
it wouldn't lose money.)

Borrowers in most states are allowed to walk away
from their mortgages, surrendering only their downpayments (if any) while
dumping their soured housing bets on a bank. Change that even slightly and
mortgage brokers and home builders would find it a lot harder to coax people
into more house than they can afford.

Mortgage middlemen who don't have "skin in the
game" and feckless rating agencies have also been routine targets of blame.
But both are basically ticket punchers for large institutions that should
have and would have been assessing their own risk, except that their own
creditors, including depositors, judged them "too big to fail," creating a
milieu where they could prosper without being either transparent or
cautious. We haven't even tried to fix this, say by requiring banks to take
on a class of debtholder who would agree to be converted to equity in a
bailout. Then there'd be at least one sophisticated marketplace demanding
assurance that a bank is being run in a safe and sound manner. (Sadly, the
commission's report only reinforces the notion that regulators are
responsible for keeping your money safe, not you.)

The FCIC Chairman Phil Angelides is not stupid, but
he is a politician. His report contains tidbits that will be useful to
historians and economists. But it's also a report that "explains" poorly.
His highly calculated sound bite, peddled from one interview to the next,
that the crisis was "avoidable" is worthless, a nonrevelation. Everything
that happens could be said to happen because somebody didn't prevent it. So
what? Saying so is saying nothing.

Mr. Angelides has gone around trying to convince
audiences that the commission's finding was hard hitting. It wasn't. It was
soft hitting. More than any other goal, it strives mainly to say nothing
that would actually be inconvenient to Barack Obama, Harry Reid, Barney
Frank or even most Republicans in Congress. In that, it succeeded.

Occupy Wall Street is denouncing banks and Wall
Street for "selling toxic mortgages" while "screwing investors and
homeowners." And the federal government recently announced it will be suing
mortgage originators whose low-quality underwriting standards produced
ballooning losses for Fannie Mae and Freddie Mac.

Have they fingered the right culprits?

There is no doubt that reductions in
mortgage-underwriting standards were at the heart of the subprime crisis,
and Fannie and Freddie's losses reflect those declining standards. Yet the
decline in underwriting standards was largely a response to mandates,
beginning in the Clinton administration, that required Fannie Mae and
Freddie Mac to steadily increase their mortgages or mortgage-backed
securities that targeted low-income or minority borrowers and "underserved"
locations.

The turning point was the spring and summer of
2004. Fannie and Freddie had kept their exposures low to loans made with
little or no documentation (no-doc and low-doc loans), owing to their
internal risk-management guidelines that limited such lending. In early
2004, however, senior management realized that the only way to meet the
political mandates was to massively cut underwriting standards.

The risk managers complained, especially at Freddie
Mac, as their emails to senior management show. They refused to endorse the
move to no-docs and battled unsuccessfully against the reduced underwriting
standards from April to September 2004. Here are some highlights:

On April 1, 2004, Freddie Mac risk manager David
Andrukonis wrote to Tracy Mooney, a vice president, that "while you, Don [Bisenius,
a senior vice president] and I will make the case for sound credit, it's not
the theme coming from the top of the company and inevitably people down the
line play follow the leader."

Risk managers had already experimented with lower
lending standards and knew the dangers. In another email that day, Mr.
Bisenius wrote to Michael May (another senior vice president), "we did
no-doc lending before, took inordinate losses and generated significant
fraud cases. I'm not sure what makes us think we're so much smarter this
time around."

On April 5, Mr. Andrukonis wrote to Chief Operating
Officer Paul Peterson, "In 1990 we called this product 'dangerous' and
eliminated it from the marketplace." He also argued that housing prices were
already high and unlikely to rise further: "We are less likely to get the
house price appreciation we've had in the past 10 years to bail this program
out if there's a hole in it."

Donna Cogswell, a colleague of Mr. Andrukonis,
warned that Fannie and Freddie's decisions to debase underwriting standards
would have widespread ramifications for the mortgage market. In a Sept. 7
email to Freddie Mac CEO Dick Syron and others, she specifically described
the ramifications of Freddie Mac's continuing participation in the market as
effectively "mak[ing] a market" in no-doc mortgages.

Ms. Cogswell's Sept. 4 email to Mr. Syron and
others also anticipated the potential human costs of the mortgage crisis.
She tried to sway management by appealing to their decency: "[W]hat better
way to highlight our sense of mission than to walk away from profitable
business because it hurts the borrowers we are trying to serve?"

Politics—not shortsightedness or incompetent risk
managers—drove Freddie Mac to eliminate its previous limits on no-doc
lending. Commenting on what others referred to as the "push to do more
affordable [lending] business," Senior Vice President Robert Tsien wrote to
Dick Syron on July 14, 2004: "Tipping the scale in favor of no cap [on
no-doc lending] at this time was the pragmatic consideration that, under the
current circumstances, a cap would be interpreted by external critics as
additional proof we are not really committed to affordable lending."

Sensing that his warnings were being ignored, Mr.
Andrukonis wrote to Michael May on Sept. 8: "At last week's risk management
meeting I mentioned that I had reached my own conclusion on this product
from a reputation risk perspective. I said that I thought you and or Bob
Tsien had the responsibility to bring the business recommendation to Dick [Syron],
who was going to make the decision. . . . What I want Dick to know is that
he can approve of us doing these loans, but it will be against my
recommendation."

The decision by Fannie and Freddie to embrace
no-doc lending in 2004 opened the floodgates of bad credit. In 2003, for
example, total subprime and Alt-A mortgage originations were $395 billion.
In 2004, they rose to $715 billion. By 2006, they were more than $1
trillion.

In a painstaking forensic analysis of the sources
of increased mortgage risk during the 2000s, "The Failure of Models that
Predict Failure," Uday Rajan of the University of Michigan, Amit Seru of the
University of Chicago and Vikrant Vig of London Business School show that
more than half of the mortgage losses that occurred in excess of the rosy
forecasts of expected loss at the time of mortgage origination reflected the
predictable consequences of low-doc and no-doc lending. In other words, if
the mortgage-underwriting standards at Fannie and Freddie circa 2003 had
remained in place, nothing like the magnitude of the subprime crisis would
have occurred.

Taxpayer losses at Fannie and Freddie alone may
exceed $300 billion. The costs of the financial collapse and recession
brought on by the mortgage bust are immeasurably higher. Unfortunately, the
Obama administration has perpetuated the low underwriting standards that
gave us the crisis and encouraged the postponement of foreclosures by
lending support to various states' efforts to sue originators for robo-signing
violations.

At this point time in 2011 there's only marginal benefit in identifying all
the groups like credit agencies and CPA audit firms that violated
professionalism leading up to the subprime crisis. The credit agencies,
auditors, Wall Street investment banks, Fannie Mae, and Freddie Mack were all
just hogs feeding on the trough of bad and good loans originating on Main
Streets of every town in the United States.

If the Folks on Main Street that Approved the Mortgage Loans in the First
Stage Had to Bear the Bad Debt Risks There Would've Been No Poison to Feed Upon
by the Hogs With Their Noses in the Trough Up to and Including Wall Street and
Fannie and Freddie.

If the Folks on Main Street that Approved the Mortgage Loans in the First
Stage Had to Bear the Bad Debt Risks All Would've Been Avoided
The most interesting question in my mind is what might've prevented the poison (uncollectability)
in the real estate loans from being concocted in the first place. What
might've prevented it was for those that approved the loans (Main Street banks
and mortgage companies in towns throughout the United States) to have to bear
all or a big share of the losses when borrowers they approved defaulted.

Instead those lenders that approved the loans easily passed those loans up
the system without any responsibility for their reckless approval of the
loans in the first place. It's easy to blame Barney Frank for making it
easier for poor people to borrow more than they could ever repay. But the fact
of the matter is that the original lenders like Countrywide were approving
subprime mortgages to high income people that also could not afford their
payments once the higher prime rates kicked in under terms of the subprime
contracts. If lenders like Countrywide had to bear a major share of the bad debt
losses the lenders themselves would've been more responsible about only
approving mortgages that had a high probability of not going into default.
Instead Countrywide and the other Main Street lenders got off scott free until
the real estate bubble finally burst.

And why would a high income couple refinance a fixed rate mortgage with a
risky subprime mortgage that they could not afford when the higher rates kicked
in down the road? The answer is that the hot real estate market before the crash
made that couple greedy. They believed that if they took out a subprime loan
with a very low rate of interest temporarily that they could turn over their
home for a relatively huge profit and then upgrade to a much nicer mansion on
the hill from the profits earned prior to when the subprime rates kicked into
higher rates.

When the real estate bubble burst this couple got left holding the bag and
received foreclosure notices on the homes that they had gambled away. And the
Wall Street investment banks, Fannie, and Freddie got stuck with all the poison
that the Main Street banks and mortgage companies had recklessly approved
without any risk of recourse for their recklessness.

If the Folks on Main Street that Approved the Mortgage Loans in the First
Stage Had to Bear the Bad Debt Risks There Would've Been No Poison to Feed Upon
by the Hogs With Their Noses in the Trough Up to and Including Wall Street and
Fannie and Freddie.

In late February, Charles Ferguson’s film – Inside
Job – won the Academy Award for Best Documentary. And now the film
documenting the causes of the 2008 global financial meltdown has made its
way online (thanks to the Internet Archive). A corrupt financial industry,
its corrosive relationship with politicians, academics and regulators, and
the trillions of damage done, it all gets documented in this film that runs
a little shy of 2 hours.

To watch the film, you will need to do the
following. 1.) Look at the bottom of the film. 2.) Click the forward button
twice so that it moves beyond the initial trailer and the Academy Awards
ceremony. 3.) Wait for the little circle to stop spinning. And 4.) click
play to watch film.

Inside Job (now listed in our Free Movie
Collection) can be purchased on DVD at Amazon. We all love free, but let’s
remember that good projects cost real money to develop, and they could use
real financial support. So please consider buying a copy.

Hopefully watching or buying this film won’t be a
pointless act, even though it can rightly feel that way. As Charles Ferguson
reminded us during his Oscar acceptance speech, we are three years beyond
the Wall Street crisis and taxpayers (you) got fleeced for billions. But
still not one Wall Street exec is facing criminal charges. Welcome to your
plutocracy…

THE long-awaited Financial Crisis Inquiry
Commission report, finally published on Thursday, was supposed to be the
economic equivalent of the 9/11 commission report. But instead of a lucid
narrative explaining what happened when the economy imploded in 2008, why,
and who was to blame, the report is a confusing and contradictory mess, part
rehash, part mishmash, as impenetrable as the collateralized debt
obligations at the core of the crisis.

The main reason so much time, money and ink were
wasted — politics — is apparent just from eyeballing the report, or really
the three reports. There is a 410-page volume signed by the commission’s six
Democrats, a leaner 10-pronged dissent from three of the four Republicans,
and a nearly 100-page dissent-from-the-dissent filed by Peter J. Wallison, a
fellow at the American Enterprise Institute. The primary volume contains
familiar vignettes on topics like deregulation, excess pay and poor risk
management, and is infused with populist rhetoric and an anti-Wall Street
tone. The dissent, which explores such root causes as the housing bubble and
excess debt, is less lively. And then there is Mr. Wallison’s screed against
the government’s subsidizing of mortgage loans.

These documents resemble not an investigative
trilogy but a left-leaning essay collection, a right-leaning PowerPoint
presentation and a colorful far-right magazine. And the confusion only
continued during a press conference on Thursday in which the commissioners
had little to show and nothing to tell. There was certainly no Richard
Feynman dipping an O ring in ice water to show how the space shuttle
Challenger went down.

That we ended up with a political split is not
entirely surprising, given the structure and composition of the commission.
Congress shackled it by requiring bipartisan approval for subpoenas, yet
also appointed strongly partisan figures. It was only a matter of time
before the group fractured. When Republicans proposed removing the term
“Wall Street” from the report, saying it was too pejorative and imprecise,
the peace ended. And the public is still without a full factual account.

For example, most experts say credit ratings and
derivatives were central to the crisis. Yet on these issues, the reports are
like three blind men feeling different parts of an elephant. The Democrats
focused on the credit rating agencies’ conflicts of interest; the
Republicans blamed investors for not looking beyond ratings. The Democrats
stressed the dangers of deregulated shadow markets; the Republicans blamed
contagion, the risk that the failure of one derivatives counterparty could
cause the other banks to topple. Mr. Wallison played down both topics. None
of these ideas is new. All are incomplete.

Another problem was the commission’s sprawling,
ambiguous mission. Congress required that it study 22 topics, but
appropriated just $8 million for the job. The pressure to cover this wide
turf was intense and led to infighting and resignations. The 19 hearings
themselves were unfocused, more theater than investigation.

In the end, the commission was the opposite of
Ferdinand Pecora’s famous Congressional investigation in 1933. Pecora’s
10-day inquisition of banking leaders was supposed to be this commission’s
exemplar. But Pecora, a former assistant district attorney from New York,
was backed by new evidence of widespread fraud and insider dealings,
shocking documents that the public had never seen or imagined. His fierce
cross-examination of Charles E. Mitchell, the head of National City Bank,
Citigroup’s predecessor, put a face on the crisis.

This commission’s investigation was spiritless and
sometimes plain wrong. Richard Fuld, the former head of Lehman Brothers, was
thrown softballs, like “Can you talk a bit about the risk management
practices at Lehman Brothers, and why you didn’t see this coming?” Other
bankers were scolded, as when Phil Angelides, the commission’s chairman,
admonished Lloyd Blankfein, the chief executive of Goldman Sachs, for
practices akin to “selling a car with faulty brakes and then buying an
insurance policy on the buyer of those cars.” But he couldn’t back up this
rebuke with new evidence.

The report then oversteps the facts in its
demonization of Goldman, claiming that Goldman “retained” $2.9 billion of
the A.I.G. bailout money as “proprietary trades.” Few dispute that Goldman,
on behalf of its clients, took both sides of trades and benefited from the
A.I.G. bailout. But a Goldman spokesman told me that the report’s assertion
was false and that these trades were neither proprietary nor a windfall. The
commission’s staff apparently didn’t consider Goldman’s losing trades with
other clients, because they were focused only on deals with A.I.G. If they
wanted to tar Mr. Blankfein, they should have gotten their facts right.

Lawmakers would have been wiser to listen to
Senator Richard Shelby of Alabama, who in early 2009 proposed a bipartisan
investigation by the banking committee. That way seasoned prosecutors could
have issued subpoenas, cross-examined witnesses and developed cases.
Instead, a few months later, Congress opted for this commission, the last
act of which was to coyly recommend a few cases to prosecutors, who already
have been accumulating evidence the commissioners have never seen.

There is still hope. Few people remember that the
early investigations of the 1929 crash also failed due to political battles
and ambiguous missions. Ferdinand Pecora was Congress’s fourth chief
counsel, not its first, and he did not complete his work until five years
after the crisis. Congress should try again.

Frank Partnoy is a law professor at the University of San Diego and the
author of “The Match King: Ivar Kreuger, the Financial Genius Behind a
Century of Wall Street Scandals.”

Jensen Comment
Professor Partnoy is one of my all-time fraud fighting heroes. He was at one
time an insider in marketing Wall Street financial instrument derivatives
products and, while he was one of the bad guys, became conscience-stricken about
how the bad guys work. Although his many books are somewhat repetitive, his
books are among the best in exposing how the Wall Street investment banks are
rotten to the core.

Every now and then the so-called "quants" in economics and finance make
enormous mistakes. Probably the best known mistake, before the trillion-dollar
CDO mistakes that came to light the collapse of the real estate market in 2007,
was the "Trillion Dollar Bet" made by two Nobel Prize winning quants and their
partners in Long-Term Capital Management (LTCM) that came within a hair of
destroying most big banks and investment firms on Wall Street ---
http://www.trinity.edu/rjensen/FraudRotten.htm#LTCM

Whenever I get news of increased power of quants
on Wall Street, I think back to "The Trillion Dollar Bet" (Nova
on PBS Video) a bond trader, two Nobel Laureates, and their doctoral
students who very nearly brought down all of Wall Street and the U.S. banking
system in the crash of a hedge fund known as
Long Term Capital
Management where the biggest and most prestigious firms lost an unimaginable
amount of money ---
http://en.wikipedia.org/wiki/LTCM

In one very practical and consequential area,
though, the allure of elegance has exercised a perverse and lasting
influence. For several decades, economists have sought to express the way
millions of people and companies interact in a handful of pretty equations.

The resulting mathematical structures, known as
dynamic stochastic general equilibrium models, seek to reflect our messy
reality without making too much actual contact with it. They assume that
economic trends emerge from the decisions of only a few “representative”
agents -- one for households, one for firms, and so on. The agents are
supposed to plan and act in a rational way, considering the probabilities of
all possible futures and responding in an optimal way to unexpected shocks.

Surreal Models

Surreal as such models might seem, they have played
a significant role in informing policy at the world’s largest central banks.
Unfortunately, they don’t work very well, and they proved spectacularly
incapable of accommodating the way markets and the economy acted before,
during and after the recent crisis.

Now, some economists are beginning to pursue a
rather obvious, but uglier, alternative. Recognizing that an economy
consists of the actions of millions of individuals and firms thinking,
planning and perceiving things differently, they are trying to model all
this messy behavior in considerable detail. Known as agent-based
computational economics, the approach is showing promise.

Take, for example, a 2012 (and still somewhat
preliminary) study by a group of
economists, social scientists, mathematicians and physicists examining the
causes of the housing boom and subsequent collapse from 2000 to 2006.
Starting with data for the Washington D.C. area, the study’s authors built
up a computational model mimicking the behavior of more than two million
potential homeowners over more than a decade. The model included detail on
each individual at the level of race, income, wealth, age and marital
status, and on how these characteristics correlate with home buying
behavior.

Led by further empirical data, the model makes some
simple, yet plausible, assumptions about the way people behave. For example,
homebuyers try to spend about a third of their annual income on housing, and
treat any expected house-price appreciation as income. Within those
constraints, they borrow as much money as lenders’ credit standards allow,
and bid on the highest-value houses they can. Sellers put their houses on
the market at about 10 percent above fair market value, and reduce the price
gradually until they find a buyer.

The model captures things that dynamic stochastic
general equilibrium models do not, such as how rising prices and the
possibility of refinancing entice some people to speculate, buying
more-expensive houses than they otherwise would. The model accurately fits
data on the housing market over the period from 1997 to 2010 (not
surprisingly, as it was designed to do so). More interesting, it can be used
to probe the deeper causes of what happened.

Consider, for example, the assertion of some
prominent economists, such as Stanford University’s
John Taylor, that the
low-interest-rate policies of the Federal Reserve were
to blame for the housing bubble. Some dynamic stochastic general equilibrium
models can be used to support this view. The agent- based model, however,
suggests that interest rates
weren’t the primary driver: If you keep rates at higher levels, the boom and
bust do become smaller, but only marginally.

Leverage Boom

A much more important driver might have been
leverage -- that is, the amount of money a homebuyer could borrow for a
given down payment. In the heady days of the housing boom, people were able
to borrow as much as 100 percent of the value of a house -- a form of easy
credit that had a big effect on housing demand. In the model, freezing
leverage at historically normal levels completely eliminates both the
housing boom and the subsequent bust.

Does this mean leverage was the culprit behind the
subprime debacle and the related global financial crisis? Not necessarily.
The model is only a start and might turn out to be wrong in important ways.
That said, it makes the most convincing case to date (see my blog for more
detail), and it seems likely that any stronger case will have to be based on
an even deeper plunge into the messy details of how people behaved. It will
entail more data, more agents, more computation and less elegance.

If economists jettisoned elegance and got to work
developing more realistic models, we might gain a better understanding of
how crises happen, and learn how to anticipate similarly unstable episodes
in the future. The theories won’t be pretty, and probably won’t show off any
clever mathematics. But we ought to prefer ugly realism to beautiful
fantasy.

(Mark Buchanan, a theoretical physicist and the author of “The Social
Atom: Why the Rich Get Richer, Cheaters Get Caught and Your Neighbor Usually
Looks Like You,” is a Bloomberg View columnist. The opinions expressed are
his own.)

Jensen Comment
Bob Jensen's threads on the mathematical formula that probably led to the
economic collapse after mortgage lenders peddled all those poisoned mortgages
---

"For five years, Li's formula, known as a
Gaussian copula function, looked like an unambiguously positive
breakthrough, a piece of financial technology that allowed hugely
complex risks to be modeled with more ease and accuracy than ever
before. With his brilliant spark of mathematical legerdemain, Li made it
possible for traders to sell vast quantities of new securities,
expanding financial markets to unimaginable levels.

His method was adopted by everybody from bond
investors and Wall Street banks to ratings agencies and regulators. And
it became so deeply entrenched—and was making people so much money—that
warnings about its limitations were largely ignored.

Then the model fell apart." The article goes on to show that correlations
are at the heart of the problem.

"The reason that ratings agencies and investors
felt so safe with the triple-A tranches was that they believed there was
no way hundreds of homeowners would all default on their loans at the
same time. One person might lose his job, another might fall ill. But
those are individual calamities that don't affect the mortgage pool much
as a whole: Everybody else is still making their payments on time.

But not all calamities are individual, and
tranching still hadn't solved all the problems of mortgage-pool risk.
Some things, like falling house prices, affect a large number of people
at once. If home values in your neighborhood decline and you lose some
of your equity, there's a good chance your neighbors will lose theirs as
well. If, as a result, you default on your mortgage, there's a higher
probability they will default, too. That's called correlation—the degree
to which one variable moves in line with another—and measuring it is an
important part of determining how risky mortgage bonds are."

I would highly recommend reading the entire thing that gets much more
involved with the
actual formula etc.

The
“math error” might truly be have been an error or it might have simply been a
gamble with what was perceived as miniscule odds of total market failure.
Something similar happened in the case of the trillion-dollar disastrous 1993
collapse of Long Term Capital Management formed by Nobel Prize winning
economists and their doctoral students who took similar gambles that ignored the
“miniscule odds” of world market collapse -- -
http://www.trinity.edu/rjensen/FraudRotten.htm#LTCM

The rhetorical question is whether the failure is ignorance in model building or
risk taking using the model?

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On a recent winter’s afternoon, nine computer
science students were sitting around a conference table in the engineering
faculty at University College London. The room was strip-lit, unadorned, and
windowless. On the wall, a formerly white whiteboard was a dirty cloud,
tormented by the weight of technical scribblings and rubbings-out upon it. A
poster in the corner described the importance of having a heterogenous
experimental network, or Hen.

Every now and again, though, the discussion became
comprehensible. The students discussed annoyances – so much data about
animals! – and possibilities. One of the PhD students, Ilya Zheludev, talked
about “Wikipedia deltas” – records of deleted sections from the online
encyclopaedia. Immediately, the students hit on the idea of tracking the
Wikipedia entries of large companies and seeing what was deleted, and when.

The mood of the meeting was casual and exacting at
the same time. Galas, who is from Gdansk and once had ambitions to be a
hacker, is something of a giant at the Financial Computing Centre. One of
the first students to enrol in 2009, he has a gift for writing extremely
large computer programs. In order to carry out his own research, Galas has
built an electronic trading platform that he estimates would satisfy the
needs of a small bank. As a result, what he says goes. Galas closed the
meeting by giving the undergraduates a hard time about the overall messiness
of their programming. “I like beauty!” he declared, staring around the room.

The Financial Computing Centre at UCL, a
collaboration with the London School of Economics, the London Business
School and 20 leading financial institutions, claims to be the only
institute of its kind in Europe. Each year since its establishment in late
2008, between 600 and 800 students have applied for its 12 fully funded PhD
places, which each cost the taxpayer £30,000 per year. Dozens more
applicants come from the financial industry, where employers are willing to
subsidise up to five years of research at the tantalising intersection of
computers, data and money.

As of this winter, the centre had about 60 PhD
students, of whom 80 per cent were men. Virtually all hailed from such
forbiddingly numerate subjects as electrical engineering, computational
statistics, pure mathematics and artificial intelligence. These realms of
knowledge contain concepts such as data mining, non-linear dynamics and
chaos theory that make many of us nervous just to see written down. Philip
Treleaven, the centre’s director, is delighted by this. “Bright buggers,” he
calls his students. “They want to do great things.”

In one sense, the centre is the logical culmination
of a relationship between the financial industry and the natural sciences
that has been deepening for the past 40 years. The first postgraduate
scientists began to crop up on trading floors in the early 1970s, when
rising interest rates transformed the previously staid calculations of bond
trading into a field of complex mathematics. The most successful financial
equation of all time – the Black-Scholes model of options pricing – was
published in 1973 (the authors were awarded a Nobel prize in 1997).

Jensen Comment
The above article (blaming government regulation) is wrong, and most other
articles (blaming Wall Street) on this topic are wrong.

The primary cause of the financial crisis was fraud on Main Street. This
fraud was enabled by letting Main Street banks and other mortgage lending
companies to make high risk (often subprime) mortgage loans and sell them to
Fannie, Freddie, and Wall Street banks without retaining any of the bad debt
(default) risk. This encouraged reckless lending and outright fraud (e.g.,
property appraisal fraud). One of the best examples is how a woman on welfare
got a $100,000+ mortgage on a $10,000 shack ---
http://www.trinity.edu/rjensen/2008Bailout.htm#Sleaze

Marvene is a poor and unemployed elderly woman who lost her
shack to foreclosure in 2008.
That's after Marvene stole over $100,000 when she refinanced her $10,000
(current value) shack with a subprime mortgage in 2007.
Marvene wants to steal some more or at least get her shack back for free.
Both the Executive and Congressional branches of the U.S. Government want to
give more to poor Marvene.
Why don't I feel the least bit sorry for poor Marvene?
Somehow I don't think she was the victim of unscrupulous mortgage brokers and
property value appraisers.
More than likely she was a co-conspirator in need of $75,000 just to pay
creditors bearing down in 2007.
She purchased the shack for $3,500 about 40 years ago ---
http://online.wsj.com/article/SB123093614987850083.html

Wall Street investment banks like Lehman Bros and various others exacerbated
the fraud by slicing and dicing the financial risk of these subprime loans into
collateralized (CDO) bonds on the basis of a flawed Gaussian copula formula.

"For five years, Li's
formula, known as a
Gaussian copula function, looked like an
unambiguously positive breakthrough, a piece of financial technology that
allowed hugely complex risks to be modeled with more ease and accuracy than ever
before. With his brilliant spark of mathematical legerdemain, Li made it
possible for traders to sell vast quantities of new securities, expanding
financial markets to unimaginable levels.

His method was adopted
by everybody from bond investors and Wall Street banks to ratings agencies and
regulators. And it became so deeply entrenched—and was making people so much
money—that warnings about its limitations were largely ignored.

Then the model fell apart." The
article goes on to show that correlations are at the heart of the problem.

"The reason that
ratings agencies and investors felt so safe with the triple-A tranches was that
they believed there was no way hundreds of homeowners would all default on their
loans at the same time. One person might lose his job, another might fall ill.
But those are individual calamities that don't affect the mortgage pool much as
a whole: Everybody else is still making their payments on time.

But not all calamities
are individual, and tranching still hadn't solved all the problems of
mortgage-pool risk. Some things, like falling house prices, affect a large
number of people at once. If home values in your neighborhood decline and you
lose some of your equity, there's a good chance your neighbors will lose theirs
as well. If, as a result, you default on your mortgage, there's a higher
probability they will default, too. That's called correlation—the degree to
which one variable moves in line with another—and measuring it is an important
part of determining how risky mortgage bonds are."

I would highly recommend reading the
entire thing that gets much more involved with the
actual formula etc.

The “math error” might truly be have
been an error or it might have simply been a gamble with what was perceived as
miniscule odds of total market failure. Something similar happened in the case
of the trillion-dollar disastrous 1993 collapse of Long Term Capital Management
formed by Nobel Prize winning economists and their doctoral students who took
similar gambles that ignored the “miniscule odds” of world market collapse -- -
http://www.trinity.edu/rjensen/FraudRotten.htm#LTCM

The rhetorical question is whether the failure is
ignorance in model building or risk taking using the model?

Yesterday, on CNBC, one of the anchors asked a
question: "Who is it that the U.S. Government is bailing out with billions
of dollars? The U.S. financial institutions or the governments of various
countries that are concerned about the impact of the bad loans and the
related financial instruments on the banks in their own countries?"

Does anybody have any opinion about that?

Ganesh M Pandit
Adelphi University

September 21, 2008 reply from Bob Jensen

Hi Ganesh,

The answer to your question turns out to be quite obscure and complicated as
Hank Paulson gives upwards of of
$500 billion in bailout funds to save CitiBank and
AIG while giving zero bailout funds to Washington Mutual Bank (the largest bank
failure in the history of the world), Lehman Brothers, and Merrill Lynch. I
think the answer is that both Hank Paulson and the U.S. Congress that so
willingly voted for the bailout funding have a Hidden Agenda that I've never
seen them explain to the public.If I'm correct,
it's a noble Hidden Agenda to save the United States of America!
If Hank Paulson or Nancy Pelosi really explained this Hidden Agenda it would
reveal how fragile the economic future of America has become and would be
counterproductive to virtually all of Barack Obama's spending promises during
his campaign. I do wish, however, that Paulson, Pelosi, and Obama would
explain it to Senator Waxman so he would shut his yap.

As events unfolded I've re-written my answer to you, Ganesh, due to questions
arising that suggest a U.S. Government Hidden Agenda in the Bailout Program that
commenced in late in 2008 after it became possible that the subprime mortgage
scandal was going to drag down both the U.S. economy into a total collapse from
which it might never emerge. Clues about a Hidden Agenda are suggested in the
following questions concerning bailout funding that has emerged. These questions
include the following: while Hank Paulson, as Secretary of the Treasury, was
responsible for obtaining and spending the bailout funds:

Why did Paulson give $85 billion to bail out American Insurance
Group (AIG) and later increased it to over $100 billion in spite of
evidence that AIG's historic record of accounting fraud (hundreds of
billions), settlements by AIG's independent auditor, PwC, for
alleged complicity and incompetence in the audit (for which PwC
settled a $1.4 billion shareholder lawsuit for close to $100
million, and other lesser settlements such as Ernst & Young's
consulting settlement for $1 million? You can read more about AIG's
accounting fraud at
http://www.trinity.edu/rjensen/FraudRotten.htm#MutualFunds

As of November 2008, 2008 there were
22 banks that Paulson elected to let fail rather than to bail
out. Why did Paulson give out upwards of $300 billion to bail out CitiBank while letting Washington Mutual (WaMu), Lehman Brothers,
and Merrill Lynch fail or be bought out for a dime on the dollar
that wiped out shareholders in WaMu, Lehman, and Merrill while
saving shareholders of CitiBank? It's important to note that
CitiBank's bailout commenced privately early in 2007 long before
Paulson ever suspected the U.S. Government would eventually bail out
any banks. Citicorp was seeking bailout funds from wealthy Arabs
long before it sought out government funding. Its also important to
note that WaMu is the largest FDIC failed bank in the history of the
world, while CitiBank is the largest saved bank in the history of
the world.

To answer such questions about why some banks (and AIG) get hundreds of
billions from Hank Paulson to save creditors and shareholders and other banks
get zero in bail out funds, I begin with some important definitions.

Chocolate
This is a mortgage issued on Main Street, USA that is highly likely to be
paid in full. If an occasional default takes place, a chocolate mortgage
balance is well below the collateral value of the real estate in
foreclosure such that the unpaid balance is fully paid by the sale of the
collateral.

Turd
This is a mortgage issued on Main Street, USA that is highly likely not to
be paid in full. If a common default takes place, a turd mortgage is well
below the collateral value of the real estate in foreclosure such that the
unpaid balance is not able to be paid in full when the property is
foreclosed. Furthermore, political pressure from Congress may prevent many
foreclosures of turd mortgages.

Mortgaged Back Securities (MBSs) that were sliced up into Collateralized Debt
Obligations (CDOs)
This is a box of supposed chocolates bundled into a single security with an
AAA investment grade rating that was sold by Wall Street investment banks
who purchased the mortgage notes and bundled them up into CDO securities
that were in term sold at relatively high profits to investors, particularly
investors in foreign nations.

Questions
What's a financial long bet and how does it win or lose?
What's the distinction between a long bet speculation versus hedge?

From The Wall Street Journal Accounting Weekly Review on April 1,
2011

SUMMARY: The catastrophe in Japan has placed renewed focus on the
country's already fragile economy-and brought unexpected profits to
investors who have long bet that the nation eventually will be dragged
down by its debt problems.

DISCUSSION:

What is a hedge fund? How is a hedge fund different from mutual
funds or individual investing? What type of investor would invest in
such funds? What are the risk levels involved with investing in
hedge funds?

How did these hedge funds 'bet against Japan'? Why did some
investors think it wise to invest this way? How has the earthquake
in Japan impacted this type of investment?

What were the issues facing Japan before the earthquake? How has
the earthquake changed the situation? What is the long-term outlook
for business in the country? What are Japan's borrowing levels? How
would this impact investment in the country by businesses? By
individuals?

The catastrophe in Japan has placed renewed
focus on the country's already fragile economy—and brought unexpected
profits to investors who have long bet that the nation eventually will
be dragged down by its debt problems.

In recent years, a chorus of voices has warned
that Japan is facing an inevitable crisis to be brought on by a stagnant
economy, a shrinking population and the worst debt profile of any major
industrialized country.

Hedge-fund managers from Kyle Bass of Hayman
Advisors LP in Dallas to smaller firms like Commonwealth Opportunity
Capital have made money since the earthquake on long-held bets on
Japan's government and corporate bonds.

Though the economic toll of the earthquake is
far from clear, the immediate response in the financial markets has been
a decline in stock prices, with the Nikkei Stock Average down 7.8% in
two days (including Friday, when the quake hit near the end of the
trading day). The price for insuring against a default by Japan on its
government debt, a popular way to position for a financial crisis in
Japan, has jumped. But in a move that runs counter to the expectations
of some long-term Japan bears, the yen has strengthened on expectations
that Japanese investors and corporations will be buying yen as they
bring money home in coming weeks and months.

The price for insuring $10 million of Japanese
sovereign debt for five years in the credit-default-swap market soared
to $103,000 on Monday, from $79,000 on Friday, according to data
provider Markit.

Reflecting the skepticism about Japan's
outlook, even before the disaster, the net notional amount of Japanese
debt being insured in the swaps market had surged to $7.4 billion from
$4.1 billion a year ago, according to data from the Depository Trust &
Clearing Corp. through March 4. The number of contracts outstanding has
more than doubled.

Fresh DTCC data are due on Tuesday and will
include only the early effects of the earthquake.

Credit-default swaps of many corporate bonds
have become even more valuable, rewarding those that bet on them. Among
the biggest moves was in Tokyo Electric Power Co., owner of the
nuclear-power plants crippled by the earthquake.

Commonwealth Opportunity Capital, a $90 million
hedge fund in Los Angeles, made a profit of several million dollars on
Tokyo Electric on Monday, from an investment of less than $200,000. The
annual cost of protecting $10 million of Tokyo Electric's debt jumped to
$240,000 on Monday from $40,700 on Friday.

"Nobody wants bad things to happen to people,"
said Adam Fisher, who helps run Commonwealth Opportunity Capital. He
said the firm has been betting against Japanese corporate bonds for two
years. "But it shows how fragile that heavily levered nation is; there's
very little margin for error."

Betting against Japan has been a losing
proposition for many investors for years. Despite all the debt problems,
bond prices have continued to move higher partly because deflation, not
inflation, has been the concern. Also, domestic investors own most of
the government's debt and have been reluctant to sell.

But now, facing at least a short-term hit to
the economy from the earthquake and the likely need to issue more debt
to pay for reconstruction efforts, Japan is seeing its problems
magnified.

"Japan's choices are very, very bad," said John
Mauldin, president of Millennium Wave Advisors. "Japan has an aging
population, which is saving less, their savings rate will go negative
sometime in the next few years at which point they will have to
significantly reduce their spending, increase taxes or print money or
some combination of the three.

"In the grand scheme of things, does the
earthquake technically move it up further? Yes, but they were already
well down the path."

Continued in article

Jensen Comment
Note how long positions on national debt are often a losing proposition
unless they are hedges. In hedging situations these gains and losses are
offset by gains and losses on the hedged items to the extent that the
hedging contracts are effective. For example, a hedge fund might invest in
U.S. Treasury bonds paying a fixed rate. There is no cash flow risk on
interest payments or repayment of the face value of the bonds. However,
there is value risk since the price of these outstanding bonds in the
financial markets goes up and down daily. The hedge fund can lock in fixed
value by entering into a fair value hedge such as by entering into a plain
vanilla interest rate swap in which the fixed-amount interest payments are
swapped for variable rate payments. The value of the bonds plus the value of
the swap is thereby locked into a fixed value for which there is no value
risk. However, when hedging value risk the investor has inevitably taken on
cash flow risk. It's impossible to hedge both fair value risk and cash flow
risk. Investors must choose between one or the other.

Hedging against debt default entire is an extreme form of fair value
hedging and is usually done with a different type of hedging contract. Here
the investor is not so much concerned with interim interest payments (or
interim changes in value due to shifts in market interest rates) as he/she
is concerned with possible default on payback of the entire principal of the
debt. In other words it's more like insurance against a creditor declaring
bankruptcy to get out of repayment of all or a great portion of debt
repayment.

A credit default swap (CDS) can almost be
thought of as a form of insurance. If a borrower of money does not repay
her loan, she "defaults." If a lender has purchased a CDS on that loan
from an insurance company, the lender can then use the default as a
credit to swap it in exchange for a repayment from an insurance company.
However, one does not need to be the lender to profit from this
situation. Anyone (usually called a
speculator) can purchase a CDS. If a borrower
does not repay his loan on time and defaults not only does the lender
get paid by the insurance company, but the speculator gets paid as well.
It is in the lender's best interest that he gets his money back, either
from the borrower, or from the insurance company if the borrower is
unable to pay back his loan. However, it is in the speculator's best
interest that the borrower never repay his loan and default because that
is the only way that the speculator can then take that default, turn it
into a credit, and swap it for a cash payment from an insurance company.

A more technical way of looking at it is that a
credit default swap (CDS) is a
swap contract and agreement in which the
protection buyer of the CDS makes a series of payments (often referred
to as the CDS "fee" or "spread") to the protection seller and, in
exchange, receives a payoff if a credit instrument (typically a
bond or loan) experiences a
credit event. It is a form of
reverse trading.

A credit default swap is a bilateral contract
between the buyer and seller of protection. The CDS will refer to a
"reference entity" or "reference obligor", usually a corporation or
government. The reference entity is not a party to the contract. The
protection buyer makes quarterly premium payments—the "spread"—to the
protection seller. If the reference entity defaults, the protection
seller pays the buyer the par
valueof the bond in exchange for physical
delivery of the bond, although settlement may also be by cash or auction.A default is referred to as a "credit
event" and includes such events as failure to
pay, restructuring and bankruptcy.[2]
Most CDSs are in the $10–$20 million range with maturities between one
and 10 years.

A holder of a bond may “buy protection” to
hedge its risk of default. In this way, a CDS is similar to credit
insurance, although CDS are not similar to or subject to regulations
governing casualty or life insurance. Also, investors can buy and sell
protection without owning any debt of the reference entity. These “naked
credit default swaps” allow traders to speculate on debt issues and the
creditworthiness of reference entities. Credit default swaps can be used
to create synthetic long and short positions in the reference entity.Naked CDS constitute most of the market inCDS.In addition, credit default swaps
can also be used in capital structure arbitrage.

Credit default swaps have existed since the
early 1990s, but the market increased tremendously starting in 2003. By
the end of 2007, the outstanding amount was $62.2 trillion, falling to
$38.6 trillion by the end of 2008.

Most CDSs are documented using standard forms
promulgated by the
International Swaps and Derivatives Association (ISDA),
although some are tailored to meet specific needs.
Credit default swaps have many variations.[2]
In addition to the basic, single-name swaps, there are basket default
swaps (BDS), index CDS, funded CDS (also called a credit linked notes),
as well as loan only credit default swaps (LCDS). In addition to
corporations or governments, the reference entity can include a special
purpose vehicle issuing
asset backed securities.

Credit default swaps are not traded on an
exchange and there is no required reporting of transactions to a
government agency.During the
2007-2010 financial crisisthe lack of
transparency became a concern to regulators, as was the trillion dollar
size of the market, which could pose a
systemic riskto the economy.In March 2010, the DTCC Trade
Information Warehouse (see
Sources of Market Data) announced it would
voluntarily give regulators greater access to its credit default swaps
database

Credit Default Swap (CDS)
This is an insurance policy that essentially "guarantees" that if a CDO goes
bad due to having turds mixed in chocolates in a diversified portfolio, the
"counterparty" who purchased the CDO will recover the value fraudulently
invested in turds. On September 30, 2008 Gretchen Morgenson of The New
York Times aptly explained that the huge CDO underwriter of CDOs was the
insurance firm called AIG. She also explained that the first $85 billion
given in bailout money by Hank Paulson to AIG was to pay the counterparties
to CDS swaps. She also explained that, unlike its casualty insurance
operations, AIG had no capital reserves for paying the counterparties for
the the turds they purchased from Wall Street investment banks.

What Ms. Morgenson failed to explain, when Paulson eventually gave over
$100 billion for AIG's obligations to counterparties in CDS contracts, was
who were the counterparties who received those bailout funds. It turns out
that most of them were wealthy Arabs and some Asians who we were getting
bailed out while Paulson was telling shareholders of WaMu, Lehman Brothers,
and Merrill Lynch to eat their turds.

A plan by beleaguered Bank of America to foist
trillions of dollars of funky Merrill Lynch derivatives onto its
depositors is raising eyebrows on Wall Street.

The rarely used move will likely save the bank
millions of dollars in collateral but could put depositors’ cash behind
the eight ball.

The move also brought to light fissures between
the nation’s top banking regulators, the Federal Deposit Insurance Corp.
and the Federal Reserve, in the wake of new regulations meant to curb
the free-wheeling habits that fostered the worst crisis in a generation
back in 2008.

At issue is BofA’s decision to shift what
sources say is some $55 trillion in derivatives at Merrill Lynch to the
retail bank unit, which houses trillions in deposits insured by the
FDIC.

Critics say the move potentially imperils
everyday depositors by placing their money and savings at risk should
BofA run into trouble.

Sources say that the derivative transfers from
Merrill to BofA’s bank subsidiary were sparked by credit-rating
downgrades to the bank holding company and are meant to help BofA avoid
having to fork over more money to post as collateral to its derivative
counterparties.

BofA officials who have talked privately say
the move was requested by its counterparties and shouldn’t be perceived
as problematic for the bank giant, sources said.

A BofA spokesman declined to comment.

For weeks, BofA CEO Brian Moynihan has been
dogged about the health of one of the nation’s largest banking
franchises and its massive exposures to toxic debt after its shotgun
mergers with Merrill and Countrywide Financial during the credit crisis
three years ago.

Under Moynihan, BofA has been attempting to
right the bank’s ship and convince shareholders that the firm is healthy
and doesn’t need to raise fresh capital to backstop against potential
losses from faulty foreclosures and other mortgage-related lawsuits.

In the third quarter, BofA posted profit of
$6.23 billion, or 56 cents a share, down 15 percent from the same period
a year ago.

The bank’s shares gained 1 percent yesterday,
to $6.47. They are off 51 percent this year.

BofA’s third-quarter performance comes as fears
persist about the big bank’s ability to make money amid stiff economic
headwinds and a host of potential land mines that could see it shelling
out billions.

The derivatives transfer has irked officials at
the FDIC which, sources said, was informed of BofA’s plan to shift the
contracts to a retail deposit-taking entity just last week.

One source says that the FDIC is in the process
of reviewing the transfer and will relay its opinion to the Federal
Reserve.

But ultimately it’s the Fed that has the final
say on authorizing any transfers.

Neither the Fed nor the FDIC would comment on
BofA’s plans, which were first reported by Bloomberg.

Continued in article

Jensen Comment
What is more bizarre is that BofA really did not want to buy Merrill Lynch
at any price in the 2008 Bailout after digging deeper into the financial
records of CDO-battered Merrill Lynch.. Then Treasury Secretary Hank Paulson
for some unknown reason did not want throw Merrill Lynch under the bus in
the same manner that he threw Bear Stearns under the bus. In my opinion,
both of these giants should have been ground up in the tires of the bus.

After the subprime collapse then BofA CEO, Ken Lewis, most certainly did
not want to use BofA money to stop the free fall of Merrill Lynch. However,
U.S. Treasury Secretary Hank Paulson resorted to personal blackmail
according to Ken Lewis.
"Bank Chief Tells of U.S. Pressure to Buy Merrill Lynch," by Louise
Story and Jo Becker, The New York Times, June 11. 2009 ---
http://www.nytimes.com/2009/06/12/business/12bank.html

Actually BofA was in great shape well into the subprime mortgage crisis.
BofA had been smart enough in 2007 to hold none of the poisoned mortgages
and CDOs that plagued most of the big banks and brokerage houses like
Merrill Lynch. But in a twist of fate BofA became drawn to the fire sale
pricing of big outfits like Countrywide and Merrill Lynch that were dying
from subprime poison. BofA just did not look these gift horses in the mouth
until it was too late to get them out of the BofA stables. There's no excuse
for the stupid purchase of Countrywide which left BofA will millions of
defaulted mortgages. There is purportedly an excuse for the purchase of
Merrill Lynch. Ken Lewis was a chicken sh*t. Ironically, he eventually lost
his job anyway.

Now it appears that BofA wants to pass trillions in Merrill Lynch CDO
losses on to depositors who will pay for these losses in nickels and dimes
of daily bank charges for things like debit cards for the next 1,000 years.
In reality, the counterparties to the CDO contracts should've absorbed the
loan loss poison, but Treasury Secretary Paulson and President George Bush
did not want to piss off the investors who finance U.S. Government budget
deficits --- especially our friends in Asia and the Middle East and large
banks like Goldman that had bought these poison-laced CDO bonds.

Ironically, it is now BofA depositors who will now be paying off the bad
debts that rightfully belonged to sovereign funds of Asia and the Middle
East as well as derivatives contract counterparties at Goldman.

The Global Financial Stability Report (GFSR)
assesses key risks facing the global financial system. In normal times,
the report seeks to play a role in preventing crises by highlighting
policies that may mitigate systemic risks, thereby contributing to
global financial stability and the sustained economic growth of the
IMF’s member countries. Risks to financial stability have declined since
the October 2012 GFSR, providing support to the economy and prompting a
rally in risk assets. These favorable conditions reflect a combination
of deeper policy commitments, renewed monetary stimulus, and continued
liquidity support. The current report analyzes the key challenges facing
financial and nonfinancial firms as they continue to repair their
balance sheets and unwind debt overhangs. The report also takes a closer
look at the sovereign credit default swaps market to determine its
usefulness and its susceptibility to speculative excesses. Lastly, the
report examines the issue of unconventional monetary policy (“MP-plus”)
and its potential side effects, and suggests the use of macroprudential
policies, as needed, to lessen vulnerabilities, allowing country
authorities to continue using MP-plus to support growth while protecting
financial stability.

The analysis in this report has been
coordinated by the Monetary and Capital Markets (MCM) Department under
the general direction of José Viñals, Financial Counsellor and Director.
The project has been directed by Jan Brockmeijer and Robert Sheehy, both
Deputy Directors; Peter Dattels and Laura Kodres, Assistant Directors;
and Matthew Jones, Advisor. It has benefited from comments and
suggestions from the senior staff in the MCM department.

This particular issue draws, in part, on a
series of discussions with banks, clearing organizations, securities
firms, asset management companies, hedge funds, standards setters,
financial consultants, pension funds, central banks, national
treasuries, and academic researchers. The report reflects information
available up to April 2, 2013.

The report benefited from comments and
suggestions from staff in other IMF departments, as well as from
Executive Directors following their discussion of the Global Financial
Stability Report on April 1, 2013. However, the analysis and policy
considerations are those of the contributing staff and should not be
attributed to the Executive Directors, their national authorities, or
the IMF.

Jensen Comment
Note that much of this report deals with the state of Credit Default Swaps.

CitiBank Foreign Investment Shareholders
Although CitiBank is one of the largest banks in the world with millions of
shareholders, it's important to note that CitiBank in particular has a high
proportion of wealthy Arabs and some wealthy Chinese investors who invested
billions in 2007 and 2008 to help keep CitiBank from failing. Hence these
wealthy Arab and Chinese investors not only bought MBS-CDO investments that
unexpectedly contained turds, they also bought heavily into CitiBank common
stock that they predicted would be a high return investment. Saudi Arabian
prince Alwaleed bin Talal, has a major stake (billions of dollars) in
Citigroup.

Recently, the investment arm of the Abu Dhabi
government agreed to invest $7.5 Billion into Citigroup – a company that
makes its money through riba. The move exposes the reality of the “Islamic
Banking” initiative supported by the same government. Shar’iah compliant
transactions cannot come into reality without courts and governments that
solely abide by what Allah (swt) has revealed. Islamic economics cannot
exist without an Islamic State.
"CitiBank Bailout: A Failed Investment," The Politically Aware Muslim,"
December 14, 2007 ---
http://awaremuslim.blogspot.com/2007/12/citibank-bailout-failed-investment.html

Subprime Mortgage Fraud as
Explained by Forrest GumpMortgage Backed Securities are like boxes of
chocolates. Criminals on Wall Street and one particular U.S. Congressional
Committee stole a few chocolates from the boxes and replaced them with turds.
Their criminal buddies at Standard & Poors rated these boxes AAA Investment
Grade chocolates. These boxes were then sold all over the world to investors.
Eventually somebody bites into a turd and discovers the crime. Suddenly nobody
trusts American chocolates anymore worldwide. Hank Paulson now wants the
American taxpayers to buy up and hold all these boxes of turd-infested
chocolates for $700 billion dollars until the market for turds returns to
normal. Meanwhile, Hank's buddies, the Wall Street criminals who stole all the
good chocolates are not being investigated, arrested, or indicted. Momma always
said: "Sniff the chocolates first Forrest." Things generally don't pass the
smell test if they came from Wall Street or from Washington DC.Forrest Gump as quoted at
http://newsgroups.derkeiler.com/Archive/Rec/rec.sport.tennis/2008-10/msg02206.html

Unbooked Entitlements Debt
This is the amount owing for future entitlement obligations of the United
States for which money has not been borrowed or set aside from taxes to meet
these obligations, including unfunded military retirement pay, Veterans
Administration benefits, Social Security benefits, Medicare benefits, the
Medicare drug program, etc. The amount is unknown, but experts set this
obligation between $40 and $65 trillion --- See
Appendix A.

Booked National Debt
This is the debt of the United States that has been borrowed and interest
expense is charged for debt that has not been paid. This booked national
debt is now over $10 trillion. This was growing at a rate of nearly $4
billion per day, but it is much higher now that the bail out funds are being
borrowed as well and are not funded by taxpayers.

Foreign Investment Bankers (FIBs)
I define this group as comprised of
foreign sovereign wealth funds, foreign banks, and foreign individuals
holding more than a billion of U.S. Treasury Bonds that comprise most of the
$10 trillion current booked U.S. National Debt. These foreign "bankers" now
hold nearly 50% of what the U.S. Government currently owes. We rely heavily
on them to also buy the new U.S. Treasury borrowings that average well over
$4 billion per day. They buy this debt at relatively low interest rates due
to the historic tradition of U.S. debt as being "risk free" ---
http://en.wikipedia.org/wiki/Risk-free_interest_rate

Though a truly risk-free asset exists only in
theory, in practice most professionals and academics use short-dated
government
bondsof the currency in question. For USD
investments, usually
US Treasury bills are used, while a common
choice for EUR investments are German government bills
or Euribor rates.
The mean real interest rate of US treasury bills during the 20th century
was 0.9% p.a. (Corresponding figures for Germany are inapplicable due to
hyperinflation during the 1920s.)

These securities are considered to be risk-free
because the likelihood of these governments
defaulting is extremely low, and because the
short maturity of the bill protects the investor from interest-rate risk
that is present in all
fixed rate bonds(if interest rates go up soon
after the bill is purchased, the investor will miss out on a fairly
small amount of interest before
the bill matures and can be reinvested at the new interest rate).

Since this interest rate can be obtained with
no risk, it is implied that any additional risk taken by an investor
should be rewarded with an interest rate higher than the risk-free rate
(on an after-tax basis, which may be achieved with preferential tax
treatment; some local government US bonds give below the risk-free
rate).

Since news of the subprime mortgage scandal and the roughly $1 trillion
being borrowed for the bail out of the financial industry, the U.S. Treasury
bonds are becoming more risky in terms of the rising slope of their yield
curves. This means that the cost of borrowing more National Debt is
increasing.

The 2008 Bailout's Hidden Agenda
I speculate that the Hidden Agenda of Hank Paulson, Nancy Pelosi, Senator
Dodd, Senator Reid, and others directly engaged in obtaining the bail out
funding is to first save the FIBs, those foreign investors upon whom we
depend too heavily for obtaining both new and rolled over National Debt
at relatively low (and less steep yield curve) interest rates. The FIBs hold nearly
$5 trillion of the present National Debt and buy nearly half of the $4+
billion debt added each day on average to the National Debt. If the FIBs
commence to demand higher interest rates for new U.S. Treasury Bonds and for
maturing bonds that need to be rolled over (refinanced), the United States
of America is in deep, deep trouble because for the last eight years of the
Bush Administration, the U.S. Government's credit bubble has been ballooning
to the point of bursting when the growth in GDP can no longer absorb such
billions in debt added each day.

For evidence of this Hidden Agenda first consider the $100 billion of bailout
funds give to AIG at the blink of an eye. If AIG declared bankruptcy and could
not meet its CDS credit swap obligations to reimburse chocolate investors
who got turds, the investors hit the hardest would be the FIBs foreign investors
who now hold the lion's share of our National Debt. When Wall Street either
knowingly or unknowingly sold mortgage backed security turds and chocolates, the
FIBs would be very, very angry if we did not pay billions to buy back those
turds or otherwise repay the FIBs for their losses. Hence we gave AIG the
bailout funds to make good on the credit derivate insurance against bad mortgage
investments. This probably also accounts for the bailout funding given to Bear
Stearns.

Apparently Washington Mutual, Lehman Brothers, and Merrill Lynch were stupid
enough to keep high proportions of turds in their own portfolios. Perhaps these
were CDO investments that they had not yet unloaded on the FIBs. Whatever the
reason, wiping out the shareholder value in those companies would not impact the
cost of our National Debt nearly as much as if we let AIG fail. Since the
"Hidden Agenda" was to hold down the cost of our National Debt, AIG got bailed
out, and the others got nothing other than what it took the FDIC to make good on
banking demand deposits (checking accounts) held by customers. For example,
unlike AIG shareholders, the WaMu shareholders were wiped out.

Now Consider Citibank. For several years CitiBank has been in trouble and
FIBs from the Middle East and Asia have been investing billions in CitiBank
common stock. They in fact held large voting blocks of power in CitiBank. If
Hank Paulsen did not guarantee upwards of $300 million for the mortgage turds
held by CitiBank, the FIB foreign investors in CitiBank would be wiped out much
like the investors in WaMu were wiped out. But the "Hidden Agenda" dictates that
we keep the FIBs happy since they hold nearly 50% of our $10 trillion National
Debt.

If the FIBs decided to significantly raise the interest rates required to
roll over maturing National Debt and to purchase new U.S. Treasury Bonds, the
entire future of the United States of America is at stake. All the promises,
dreams, and plans of our new President Obama and the huge majority of Democratic
Party legislators would be dashed since the U.S. worldwide interest rate would
be much higher and no longer be viewed as risk-free. Programs such as national
health care, increased aid to states for human services, and a modernized
military force would be dashed all due to turds created by Turds on Main Street
such as mortgage brokers and banks on Main Street and Wall Street scammers who
sold them off to the FIBs and others in chocolate boxes.

I’ve often wondered why Hank Paulson never tried to explain this in the
Congressional Hearings questioning his judgment for bailing out only selected
outfits like Bear Stearns, AIG, and CitiBank. Now I think I have an answer, and
if you discover anybody who has written something similar I would really like to
know, because the media still does not seem to understand why CitiBank (the
largest saved bank in the world) is more important to the Treasury Department
than Washington Mutual (the largest bank failure in the world).

All of this of course begs the question of why the
Bailout's Hidden Agenda remains hidden when Hank Paulsen and other
leaders are asked to explain why the "fat cats" of AIG and CitiBank get bailed
out for upwards of $500 billion and the small shareholders of WaMu, Lehman, and
Merrill Lynch are told to take a hike? I think the reason is that virtually all
our leaders in Washington DC prefer not to explain or dwell upon how our booked
National Debt and our unbooked entitlement obligations have put the United
States of America in a terribly deep hole in which the
only hope of crawling back out rests in the hands of the foreign investors,
particularly those in China (which owns nearly 10% of the Federal Debt), Japan,
Singapore, and wealthy Middle Eastern oil producing states. The best we can hope
for now is continued rolling over of U.S. Treasury Bonds at the lowest possible
rates such tat our low cost of capital remains lower than the long-term fixed
rates of interest needed to revive the real estate market in the U.S. See
Appendix A.

If the cost of the National Debt should rise higher than the low interest
rate that the U.S. Government may soon be setting for home owners refinancing
their mortgages and buyers seeking new long term mortgages, then the only way
out of the deep hole may be slow the rate of increase in the National Debt with
destructive inflation that comes with printing money to pay the difference
between the borrowing rates and the spending rates of the U.S. Government.
Zimbabwe has shown us how destructive inflation can become when a nation tries
to pay its debts by simply printing more currency.

Hence I conclude that the Hidden Agenda is a noble cause to save the good
faith and credit of the United States when the National Debt is increasing $4
billion to $6 billion a day and greater deficits to come when the U.S. Congress
intends to deficit finance over the next eight years at unsurpassed billions
separating tax revenues from program expenditures.

Even if the FIBs continue to give the U.S. a great deal on borrowing rates
for the National Debt, we are in deeper trouble due to our unbooked entitlements
debt that will be coming increasingly expensive as the baby boomers age ---
http://www.trinity.edu/rjensen/entitlements.htm

We can also secure a firm
financial footing for Social Security (and Medicare) without choking off
economic growth or curtailing our flexibility to pursue other spending
priorities. Three actions are essential: (1) reduce entitlement spending
growth through some form of means testing; (2) eliminate all nonessential
spending in the rest of the budget; and (3) adopt policies that promote
economic growth. This 180-degree difference from Mr. Obama's fiscal plan
forms the basis of Sen. McCain's priorities for spending, taxes and health
care.

The problem with Mr. Obama's
fiscal plans is not that that they lack vision. On the contrary, the vision
is plain enough: a larger welfare state paid for by higher taxes. The
problem is not even that they imply change. The problem is that his plans
are statist.

While the candidate is
sending a fiscal "Ich bin ein Berliner" message to Americans, European
critics of his call for greater spending on defense are the canary in the
coal mine for what lies ahead with his vision for the United States.

Professor R. Glenn Hubbard is Dean of the
College of Business at Columbia University and a member of the President's
Council of Economic Advisors.

It may well be that the U.S. Treasury pledge most of the bailout money to AIG
and CitiBank because "they are just too big to fail" in a sense that failure of
these two might bring down the entire world wide financial house of cards. I
just don't think this is the case since CitiBank could've saved the CitiBank
creditors without saving the shareholders. This is essentially what happened
when Freddie Mac and Fannie Mae shareholders were wiped out.

Question
What's the significance of the off-balance sheet liabilities in CitiBank versus
the U.S. Treasury?

Answer
Both CitiBank and the U.S. Treasury have managed to keep more of their debts off
balance sheet than they have booked on the balance sheet. According to the
former top accountant in the U.S., David Walker, the total debt of the U.S. is
about $55 trillion (now in excess of $100 trillion), of which $11 trillion is booked on the balance sheet as
National Debt --- See Appendix A.
The total debt of CitiBank is over $2 trillion with slightly over half being
booked on the balance sheet. Some analysts argued that Citibank had a handle on
its total debt before the meltdown, but this is no longer the case ---
http://www.monkeybusinessblog.com/mbb_weblog/2008/07/citi-off-balanc.html

What's sad is that even saving the shareholders in Citibank in order to
prevent shareholder wipeouts of the shareholders from China, Singapore, Japan,
and the Middle East, that may not be enough to keep the interest rates on the
U.S. National Debt as low as we would like.
"The issuance issue," The Economist, Nov. 2--Dec. 5, 2008, Page 77 ---
http://www.economist.com/finance/displaystory.cfm?story_id=12700894

“ROLL up, roll up. Get your government bonds here.
They may not pay much, but they’re safe. Buy ’em now in case stockmarkets
don’t last.”

As the recession deepens, finance ministers round
the world may be forced to resort to the tactics of the market stallholder.
Politicians hope that deficit financing will be the way to stimulate the
economy. But someone has to buy all those bonds.

They are easy to sell at the moment. The prices of
risky assets like shares and corporate bonds have been plunging. Banks are
so desperate for the security of government paper that they are accepting
yields close to zero on three-month Treasury bills. Yields on American
ten-year Treasury bonds have fallen to around 3%, their lowest in a
generation. British government bonds, or gilts, with the same maturity are
returning about 4%, despite the rise in the budget deficit planned by
Alistair Darling, the chancellor.

Government-bond markets are benefiting from the
deteriorating economic outlook, which is leading some forecasters to predict
both a recession and a brief period of deflation in 2009. A nominal yield of
3-4% looks attractive in real terms if prices are falling.

A surge in supply could be matched by higher
demand. The potential precedent is Japan, where nearly two decades of fiscal
deficits and a deteriorating debt-to-GDP ratio have not stopped investors
from buying bonds at yields of less than 2%.

But is this really an encouraging example? Most
Americans and Europeans would not consider low government-bond yields to be
adequate compensation for the nearly two decades of sluggish economic growth
that Japan has suffered. And Japan is different from America and Britain: it
runs current-account surpluses and thus has not been dependent on foreign
capital. The Anglo-American economies rely on the kindness of strangers.

There has been no sign, so far, that foreigners are
tiring of funding the American deficit. Indeed, the dollar has risen against
most currencies (the yen is a notable exception) in recent months. Being the
world’s largest economy has helped, as has the flight out of emerging-market
currencies. But Britain does not have the same advantages. The pound was
treated for many years as a high-yielding version of the euro. That is no
longer so after recent rate cuts and sterling has suffered against both the
euro and the dollar.

Mr Islam reckons overseas investors have been
buying around 30% of recent gilt issuance. Given the losses they have
already suffered through the pound’s fall, will they step up their
purchases, especially as the growth rate of global foreign-exchange reserves
is slowing?

So domestic investors may be required to shoulder
the burden. Pension funds may be eager to add to their holdings, given the
losses they have suffered on shares and in alternative asset classes, such
as hedge funds and private equity.

But retail investors may also be needed. A rise in
the savings rate is widely forecast as the economy slows (although this is
likely to be driven by a fall in borrowing more than by a surge in savings
itself). If, as many economists forecast, the Bank of England cuts
short-term rates to 2%, British savers could be tempted by the allure of
government bonds yielding 3-4%. The same may be true in America, where
money-market funds are already offering paltry returns. This will be a big
change of habit: according to Morgan Stanley, America’s net Treasury-bond
purchases, outside those by the finance industry, have been zero since 1992.

Perhaps a more cautious generation of investors
will rediscover the virtues of government debt, as they did in the 1930s and
1940s. “People will be buying bonds as Christmas presents,” predicts Matt
King, a credit strategist at Citigroup.

Paradoxically, the real problem for governments may
only occur if they manage to revive their economies. At that point,
deflation worries will disappear and investors will switch to riskier
assets. Given the deficits in both Britain and America, it seems unlikely
that any cyclical rebound will be strong enough to bring the budget back to
balance. In 2010 or 2011, issuing government bonds may prove a much harder
(and more expensive) task.

This above section of the Essay with additional details and replies from
readers is reproduced in
Appendix Y --- Click Here

Aesop: We hang the petty thieves and appoint
the great ones to public office.

Bankers bet with their bank's capital, not
their own. If the bet goes right, they get a huge bonus; if it
misfires, that's the shareholders' problem.
Sebastian Mallaby. Council on Foreign Relations, as quoted by Avital
Louria Hahn, "Missing: How Poor Risk-Management Techniques
Contributed to the Subprime Mess," CFO Magazine, March 2008,
Page 53 ---
http://www.cfo.com/article.cfm/10755469/c_10788146?f=magazine_featured
Now that the Fed is going to bail out these crooks with taxpayer
funds makes it all the worse.

The bourgeoisie can
be termed as any group of people who are discontented with what they
have, but satisfied with what they are
Nicolás Dávila

That some bankers have ended up in prison is not a
matter of scandal, but what is outrageous is the fact that all the others are
free.
Honoré de Balzac

The United States is headed toward a new
financial crisis. History gives many examples of countries with high actual
and expected money growth, unsustainable budget deficits, and a currency
expected to depreciate. Unless these countries made massive policy changes,
they ended in crisis. We will escape only if we act forcefully and soon.

As long ago as the 1960s, then French
President Charles de Gaulle complained that the U.S. had the "exorbitant
privilege" of financing its budget deficit by issuing more dollars. Massive
purchases of dollar debt by foreigners can of course delay the crisis, but
today most countries have their own deficits to finance. It is unwise to
expect them, mainly China, to continue financing up to half of ours for the
next 10 or more years. Our current and projected deficits are too large
relative to current and prospective world saving to rely on that outcome.

Worse, banks' idle reserves that are
available for lending reached $1 trillion last week. Federal Reserve
Chairman Ben Bernanke said repeatedly in the past that excess reserves would
run down when banks and other financial companies repaid their heavy
short-term borrowing to the Fed. The borrowing has been repaid but idle
reserves have increased. Once banks begin to expand loans or finance even
more of the massive deficits, money growth will rise rapidly and the dollar
will sink to new lows. Do we have to wait for a crisis before we replace
promises with effective restraint?

Many market participants reassure
themselves that inflation won't come by noting the decline in yields on
longer-term Treasury bonds and the spread between nominal Treasury yields
and index-linked TIPS that protect against inflation. They measure
expectations of higher inflation by the difference between these two rates,
and imply long-term investors aren't demanding higher interest rates to
protect themselves against it. But those traditional inflation-warning
indicators are distorted because the Fed lends money at about a zero rate
and the banks buy Treasury securities, reducing their yield and thus the
size of the inflation premium.

Further, the Fed is buying massive amounts
of mortgages to depress and distort the mortgage rate. This way of
subsidizing bank profits and increasing their capital bails out these
institutions but avoids going to Congress for more money to do so. It
follows the Fed's usual practice of protecting big banks instead of the
public.

The administration admits to about $1
trillion budget deficits per year, on average, for the next 10 years. That's
clearly an underestimate, because it counts on the projected $200 billion to
$300 billion of projected reductions in Medicare spending that will not be
realized. And who can believe that the projected increase in state spending
for Medicaid can be paid by the states, or that payments to doctors will be
reduced by about 25%?

While Chinese government purchases of our
debt may delay a dollar and debt crisis, they also delay any effective
program to reduce the size of that crisis. It is far better to begin
containing the problem before we blow a hole in the dollar and start another
downturn.

A weak economy is a poor time to reduce
current government spending or raise tax rates, but we don't require
draconian immediate changes. We do need a fully specified, multi-year
program to restore fiscal probity by reducing spending, and a budget rule
that limits the size and frequency of deficits. The plan should be announced
in a rousing speech by the president. The emphasis should be on reducing
government spending.

The Obama administration chooses to blame
outsize deficits on its predecessor. That's a mistake, because it hides a
structural flaw: We no longer have any way of imposing fiscal restraint and
financial prudence. Federal, state and local governments understate future
spending and run budget deficits in good times and bad. Budgets do not
report these future obligations.

Except for a few years in the 1990s, both
parties have been at fault for decades, and the Obama administration is one
of the worst offenders. Its $780 billion stimulus bill, enacted earlier this
year, has been wasteful and ineffective. The Council of Economic Advisers
was so pressed to justify the spending spree that it shamefully invented a
number called "jobs saved" that has never been seen before, has no agreed
meaning, and no academic standing.

One reason for the great inflation of the
1970s was that the Federal Reserve gave primacy to reducing unemployment.
But attempts to tame inflation later didn't last, and the result was a
decade of high and rising unemployment and prices. It did not end until the
public accepted temporarily higher unemployment—more than 10.5% in the fall
of 1982—to reduce inflation.

Another error of the 1970s was the
assumption there was a necessary trade-off along a stable Phillips Curve
between unemployment and inflation—in other words, that more inflation was
supposed to lower unemployment. Instead, both rose. The Fed under Paul
Volcker stopped making those errors, and inflation fell permanently for the
first time since the 1950s.

Both errors are back. The Fed and most
others do not see inflation in the near term. Neither do I. High inflation
is unlikely in 2010. That's why a program beginning now should start to
lower excess reserves gradually so that the Fed will not have to make its
usual big shift from excessive ease to severe contraction that causes a
major downturn in the economy.

A steady, committed policy to reduce
future inflation and lower future budget deficits will avoid the crisis that
current policies will surely bring. Low inflation and fiscal prudence is the
right way to strengthen the dollar and increase economic well being.

Dr. Meltzer is professor of political economy at Carnegie Mellon
University and the author of the multi-volume "A History of the Federal
Reserve" (University of Chicago, 2004 and 2010).

Breaking the Bank Frontline
VideoIn Breaking the Bank, FRONTLINE producer Michael Kirk
(Inside the Meltdown, Bush’s War) draws on a rare combination of high-profile
interviews with key players Ken Lewis and former Merrill Lynch CEO John Thain to
reveal the story of two banks at the heart of the financial crisis, the rocky
merger, and the government’s new role in taking over — some call it
“nationalizing” — the American banking system. Simoleon Sense, September 18,
2009 ---
http://www.simoleonsense.com/video-frontline-breaking-the-bank/
Bob Jensen's threads on the banking bailout ---
http://www.trinity.edu/rjensen/2008Bailout.htm

Does anyone
remember what happened on Christmas Eve last year? In one of the most
expensive Christmas presents ever, the government
removedthe $400 billion limit on their Fannie and
Freddie guaranty. This act increased taxpayer liabilities by
six trillion dollars; however, the news was lost
in the holiday cheer. This is one instance in a broader campaign to
manipulate the public perception, gradually depriving us of independent
thought.

Consider another example: what news story broke on April 16, 2010? Most of
us would say the SEC's
lawsuitagainst Goldman Sachs. Goldman is the
market leader in "ripping the client's face off," in this instance creating
a worst-of-the-worst pool of securities so Paulson & Co could bet against
it. Many applauded the SEC for this action. Never mind that singling out
one vice president (the "Fabulous Fab") and one instance of fraud is like
charging Al Capone with tax evasion. The dog was wagged.

Very
few caught the real news that day, namely the damning
complicityof the SEC in the Stanford Ponzi
scheme. Clearly, Stanford was the bigger story, costing thousands of
investors
billionsof dollars while Goldman later settled
for half a
billion. Worse, the SEC knew about Stanford since
1997, but instead of shutting it down, people left the SEC to workfor Stanford. This story should have caused
widespread outrage and reform of the SEC; instead it was buried in the back
pages and lost to the public eye.

Lest we
think the timing of these was mere coincidence, the Goldman lawsuit was
settled on July 15, 2010, the same day the financial reform package
passed. The government threw Goldman to the
wolves in order to hide its own shame. When the government had its desired
financial reforms, it let Goldman settle. These examples demonstrate a
clear pattern of manipulation. Unfortunately, our propaganda problem runs
far deeper than lawsuits and Ponzi schemes.

Here is a
more important question: which companies own half of all
subprimeand
Alt-A(liar loan) bonds? Paul Krugman writes that
these companies were "mainly out of the picture during the housing bubble's
most feverish period, from 2004 to 2006. As a result, the agencies played
only a minor role in the epidemic of bad lending."[iii] This phrase is
stupefying. How can a pair of companies comprise half of a market and yet
have no major influence in it? Subprime formed the core of the financial
crisis, and Fannie and Freddie (the "agencies") formed the core of the
subprime market. They were not "out of the picture" during the subprime
explosion, they were the picture. The fact that a respectable Nobel
prize-winner flatly denies this is extremely disturbing.

Amazingly, any attempt to hold the government accountable for its role in
the subprime meltdown is dismissed as right-wing
propaganda. This dismissal is left-wing
propaganda. It was the government that initiated securitization as a tool
to dispose of
RTCassets. Bill Clinton ducks all
responsibility, ignoring how his administration imposed arbitrary
quotason any banks looking to merge as Attorney
General Janet Reno "threatened legal action against lenders whose racial
statistics raised her suspicions."[iv] Greenspan fueled the rise of
subprime derivatives by lowering rates,[v] lowering reserves,[vi] and
beating down reasonable
opposition. And at the center of it all were
Fannie and Freddie
bribing officials, committing fraud,
dominating private-sector
competition, and expanding to a
six-trillion-dollar debacle. The fact that these facts are dismissed as
propaganda shows just how divorced from reality our ‘news' has become. Yes,
half of all economists are employed by the
government, but this is no reason to flout one's
professional responsibility. As a nation we need to consider all the facts,
not just those that are politically expedient.

One of America's great
accomplishments in the last half-century was the so-called "democratization"
of the financial markets.

No longer just for the upper
crust, investing became a way for the burgeoning middle class to accumulate
wealth. Mutual funds exploded in size and number, 401k plans made savings
and investing easy, and the excitement of participating in the growth of our
economy gripped an ever larger percentage of the population.

Despite a backdrop of
doubters -- those who knowingly asserted that outperforming the average was
an impossibility for the small investor -- there was a growing consensus
that the rules were sufficient to protect the mom-and-pop investor from the
sharks that swam in the water.

That sense of fair play in
the market has been virtually destroyed by the bubble burstings and market
drops of the past few years.

Recent rebounds
notwithstanding, most people now are asking whether the system is
fundamentally rigged. It's not just that they have an understandable
aversion to losing their life savings when the market crashes; it's that
each of the scandals and crises has a common pattern: The small investor was
taken advantage of by the piranhas that hide in the rapidly moving currents.

And underlying this pattern is
a simple theme: conflicts of interest that violated the duty the market
players had to their supposed clients.

It is no wonder that
cynicism and anger have replaced what had been the joy of participation in
the capital markets.

Take a quick run through a
few of the scandals:

Analysts at major
investment banks promote stocks they know to be worthless, misleading
the investors who rely on their advice yet helping their
investment-banking colleagues generate fees and woo clients.

Ratings agencies slap AAA
ratings on debt they know to be dicey in order to appease the issuers --
who happen to pay the fees of the agencies, violating the rating
agency's duty to provide the marketplace with honest evaluations.

Executives receive outsized
and grotesque compensation packages -- the result of the perverted
recommendations of compensation consultants whose other business depends
upon the goodwill of the very CEOs whose pay they are opining upon, thus
violating the consultants' duty to the shareholders of the companies for
whom they are supposedly working.

Mutual funds charge
exorbitant fees that investors have to absorb -- fees that dramatically
reduce any possibility of outperforming the market and that are set by
captive boards of captive management companies, not one of which has
been replaced for inadequate performance, violating their duty to guard
the interests of the fund investors for whom they supposedly work.

"High-speed trading"
produces not only the reality of a two-tiered market but also the
probability of front-running -- that is, illegally trading on
information not yet widely known -- that eats into the possible profits
of the retail clients supposedly being served by these very same market
players, violating the obligation of the banks to get their clients
"best execution" without stepping between their customers and the best
available price.

AIG (AIG,
news,
msgs)is bailed out, costing taxpayers
tens of billions of dollars, even though (as we later learned) the big
guys knew that AIG was going down and were able to hedge and cover their
positions. Smaller investors are left holding the stock, and all of us
are left picking up the tab.

The unifying theme is
apparent: Access to information and advice, the very lifeblood of a level
playing field, is not where it needs to be. The small investor still doesn't
have a fair shot.

While there have been
case-specific remedies, the aggregate effect of all the scandals is still to
deny the market the most essential of ingredients: the presumption of
integrity.

The issue confronting those
who wish to solve this problem is that there really is no simple fix.

JPMorgan Chase may be sued
by US regulators for violating securities laws and market rules related to
the sale of bonds and interest-rate swaps to Jefferson County, Alabama.

The potential Securities and
Exchange Commission action is the latest twist in a complex debt financing
saga which has already led to charges against Jefferson County officials and
which has left the municipality struggling to avoid default on over $3bn of
debt, much of it taken on to improve its sewage system.

JPMorgan said in a
regulatory filing, made late on Thursday just as the results of bank stress
tests were being released, that it had been told about the SEC action on
April 21. It said it “has been engaged in discussions with the SEC staff in
an attempt to resolve the matter prior to litigation”. The bank had no
further comment on Friday.

Jefferson County is one of
the most indebted municipalities in the US due to its expensive overhaul of
its sewage system. JPMorgan is one of the lenders which has repeatedly
extended the deadline on payments due by Jefferson County on its debt and
derivatives.

A law is currently being
considered that would create a new tax which would provide revenues to pay
the sewer debt. If Jefferson County defaults, it would be the biggest by a
US municipality, dwarfing the problems faced by California’s Orange County
in the 1990s.

The mayor of Birmingham,
Alabama, and two of his friends were last year charged by US regulators in
connection with an undisclosed payment scheme related to municipal bond and
swap deals.

The SEC alleged that Larry
Langford, the mayor, received more than $156,000 in cash and benefits from a
broker hired to arrange bond offerings and swap agreements on behalf of
Jefferson County, where Birmingham is located.

Although the details of the
SEC investigation are not known, it is likely to be related to the payment
scheme through which banks like JPMorgan paid fees to local brokers at the
request of Jefferson County.

The credit crisis has
brought to light numerous problems in the municipal bond markets. Many
borrowers relied on bond insurance to sell their deals, and the collapse in
the credit ratings of bond insurers has made it difficult for many to raise
funds or to do so at low interest rates.

The legislation's guidelines for crafting the
rescue plan were clear: the TARP should protect home values and consumer
savings, help citizens keep their homes and create jobs. Above all, with the
government poised to invest hundreds of billions of taxpayer dollars in
various financial institutions, the legislation urged the bailout's
architects to maximize returns to the American people.

That $700 billion bailout has since
grown into a more than $12 trillion commitment by
the US government and the Federal Reserve. About $1.1 trillion
of that is taxpayer money--the TARP money and an additional $400 billion
rescue of mortgage companies Fannie Mae and Freddie Mac. The TARP now
includes twelve separate programs, and recipients range from megabanks like
Citigroup and JPMorgan Chase to automakers Chrysler and General Motors.

Seven months in, the bailout's impact is
unclear. The Treasury Department has used the
recent "stress test" resultsit applied to
nineteen of the nation's largest banks to suggest that the worst might be
over; yet the
International Monetary Fund, as well as economists
like New York University professor and economist Nouriel Roubini and New
York Times columnist Paul Krugman
predict greater losses in US markets, rising unemployment and generally tougher economic times ahead.

What cannot be disputed, however, is the
financial bailout's biggest loser: the American taxpayer. The US government,
led by the Treasury Department, has done little, if anything, to maximize
returns on its trillion-dollar, taxpayer-funded investment. So far, the
bailout has favored rescued financial institutions bysubsidizing their
losses to the tune of $356 billion,
shying away from much-needed management changes and--with the exception of
the automakers--letting companies take taxpayer money without a coherent
plan for how they might return to viability.

The bailout's perks have been no less
favorable for private investors who are now picking over the economy's
still-smoking rubble at the taxpayers' expense. The newer bailout programs
rolled out by Treasury Secretary Timothy Geithner give private equity firms,
hedge funds and other private investors significant leverage to buy "toxic"
or distressed assets, while leaving taxpayers stuck with the lion's share of
the risk and potential losses.

Given the lack of transparency and
accountability, don't expect taxpayers to be able to object too much. After
all, remarkably little is known about how TARP recipients have used the
government aid received. Nonetheless, recent government reports,
Congressional testimony and
commentaries offer those patient enough to pore over hundreds of pages of
material glimpses of just how Wall Street friendly the bailout actually is.
Here, then, based on the most definitive data and analyses available, are
six of the most blatant and alarming ways taxpayers have been scammed by the
government's $1.1-trillion, publicly funded bailout.

1. By
overpaying for its TARP investments, the Treasury Department provided
bailout recipients with generous subsidies at the taxpayer's expense.

When the Treasury Department ditched its
initial plan to buy up "toxic" assets and instead invest directly in
financial institutions, then-Treasury Secretary Henry Paulson Jr. assured
Americans that they'd get a fair deal. "This is an investment, not an
expenditure, and there is no reason to expect this program will cost
taxpayers anything," he
saidin October 2008.

Yet the Congressional Oversight Panel
(COP), a five-person group tasked with ensuring that the Treasury Department
acts in the public's best interest, concluded in its
monthly report for Februarythat
the department had significantly overpaid by tens of billions of dollars for
its investments. For the ten largest TARP investments made in 2008, totaling
$184.2 billion, Treasury received on average only $66 worth of assets for
every $100 invested. Based on that shortfall, the panel calculated that
Treasury had received only $176 billion in assets for its $254 billion
investment, leaving a $78 billion hole in taxpayer pockets.

Not all investors subsidized the
struggling banks so heavily while investing in them. The COP report notes
that private investors received much closer to fair market value in
investments made at the time of the early TARP transactions. When, for
instance,
Berkshire Hathaway invested $5 billion in Goldman Sachsin September, the Omaha-based company received
securities worth $110 for each $100 invested. And when
Mitsubishi invested in Morgan Stanleythat same month, it received securities worth
$91 for every $100 invested.

As of May 15, according to the
Ethisphere TARP Index, which
tracks the government's bailout investments, its various investments had
depreciated in value by almost $147.7 billion. In other words, TARP's losses
come out to almost $1,300 per American taxpaying household.

2. As the
government has no real oversight over bailout funds, taxpayers remain in the
dark about how their money has been used and if it has made any difference.

While the Treasury Department can make
TARP recipients report on just how they spend their government bailout
funds, it has chosen not to do so. As a result, it's unclear whether
institutions receiving such funds are using that money to increase
lending--which would, in turn, boost the economy--or merely to fill in holes
in their balance sheets.

Neil M. Barofsky, the special inspector
general for TARP, summed the situation up this way in his office's April
quarterly report to Congress: "The American people have a right to know how
their tax dollars are being used, particularly as billions of dollars are
going to institutions for which banking is certainly not part of the
institution's core business and may be little more than a way to gain access
to the low-cost capital provided under TARP."

This lack of transparency makes the
bailout process highly susceptible to fraud and corruption.
Barofsky's report statedthat twenty separate
criminal investigations were already underway involving corporate fraud,
insider trading and public corruption. He also
toldthe Financial Times
that his office was investigating whether banks manipulated their books to
secure bailout funds. "I hope we don't find a single bank that's cooked its
books to try to get money, but I don't think that's going to be the case."

Economist Dean Baker, co-director of the
Center for Economic and Policy Research in Washington, suggested to
TomDispatch in an interview that the opaque and complicated nature of the
bailout may not be entirely unintentional, given the difficulties it raises
for anyone wanting to follow the trail of taxpayer dollars from the
government to the banks. "[Government officials] see this all as a Three
Card Monte, moving everything around really quickly so the public won't
understand that this really is an elaborate way to subsidize the banks,"
Baker says, adding that the public "won't realize we gave money away to some
of the richest people."

3. The
bailout's newer programs heavily favor the private sector, giving investors
an opportunity to earn lucrative profits and leaving taxpayers with most of
the risk.

Under Treasury Secretary Geithner, the
Treasury Department has greatly expanded the financial bailout to troubling
new programs like the Public-Private Investment Program (PPIP) and the Term
Asset-Backed-Securities Loan Facility (TALF). The PPIP, for example,
encourages private investors to buy "toxic" or risky assets on the books of
struggling banks. Doing so, we're told, will get banks lending again because
the burdensome assets won't weigh them down. Unfortunately, the incentives
the Treasury Department is offering to get private investors to participate
are so generous that the government--and, by extension, American
taxpayers--are left with all the downside.

Consider an asset that
has a 50-50 chance of being worth either zero or $200 in a year's time. The
average "value" of the asset is $100. Ignoring interest, this is what the
asset would sell for in a competitive market. It is what the asset is
'worth.' Under the plan by Treasury Secretary Timothy Geithner, the
government would provide about 92 percent of the money to buy the asset but
would stand to receive only 50 percent of any gains, and would absorb almost
all of the losses. Some partnership!

Assume that one of the
public-private partnerships the Treasury has promised to create is willing
to pay $150 for the asset. That's 50 percent more than its true value, and
the bank is more than happy to sell. So the private partner puts up $12, and
the government supplies the rest--$12 in "equity" plus $126 in the form of a
guaranteed loan.

If, in a year's time,
it turns out that the true value of the asset is zero, the private partner
loses the $12, and the government loses $138. If the true value is $200, the
government and the private partner split the $74 that's left over after
paying back the $126 loan. In that rosy scenario, the private partner more
than triples his $12 investment. But the taxpayer, having risked $138, gains
a mere $37."

Worse still, the PPIP can be easily
manipulated for private gain. As economist
Jeffrey Sachs has described it, a
bank with worthless toxic assets on its books could actually set up its
own public-private fund to bid on those assets. Since no true bidder
would pay for a worthless asset, the bank's public-private fund would win
the bid, essentially using government money for the purchase. All the
public-private fund would then have to do is quietly declare bankruptcy and
disappear, leaving the bank to make off with the government money it
received. With the PPIP deals set to begin in the coming months, time will
tell whether private investors actually take advantage of the program's
flaws in this fashion.

The Treasury Department's TALF program
offers equally enticing possibilities for potential bailout profiteers,
providing investors with a chance to double, triple or even quadruple their
investments. And like the PPIP, if the deal goes bad, taxpayers absorb most
of the losses. "It beats any financing that the private sector could ever
come up with," a Wall Street trader commented
in a recent Fortune magazine story. "I almost want to say it is
irresponsible."

4. The
government has no coherent plan for returning failing financial institutions
to profitability and maximizing returns on taxpayers' investments.

Compare the treatment of the auto industry
and the financial sector, and a troubling double standard emerges. As a
condition for taking bailout aid, the government required Chrysler and
General Motors to present
detailed planson how the
companies would return to profitability. Yet the Treasury Department
attached minimal conditions to the billions injected into the largest
bailed-out financial institutions. Moreover, neither Geithner nor Lawrence
Summers, one of President Barack Obama's top economic advisors, nor the
president himself has articulated any substantive plan or vision for how the
bailout will help these institutions recover and, hopefully, maximize
taxpayers' investment returns.

The Congressional Oversight Panel
highlighted the absence of such a comprehensive plan in its
January report. Three months into
the bailout, the Treasury Department "has not yet explained its strategy,"
the report stated. "Treasury has identified its goals and announced its
programs, but it has not yet explained how the programs chosen constitute a
coherent plan to achieve those goals."

Today, the department's endgame for the
bailout still remains vague. Thomas Hoenig, president of the Federal Reserve
Bank of Kansas City,
wrotein the Financial Times
in May that the government's response to the financial meltdown has been "ad
hoc, resulting in inequitable outcomes among firms, creditors, and
investors." Rather than perpetually prop up banks with endless taxpayer
funds, Hoenig suggests, the government should allow banks to fail. Only
then, he believes, can crippled financial institutions and systems be fixed.
"Because we still have far to go in this crisis, there remains time to
define a clear process for resolving large institutional failure. Without
one, the consequences will involve a series of short-term events and far
more uncertainty for the global economy in the long run."

The healthier and more profitable bailout
recipients are once financial markets rebound, the more taxpayers will earn
on their investments. Without a plan, however, banks may limp back to
viability while taxpayers lose their investments or even absorb further
losses.

The government may not have a long-term
strategy for its trillion-dollar bailout, but its guiding principle, however
misguided, is clear: what's good for Wall Street will be best for the rest
of the country.

On the day the mega-bank stress tests were
officially released, another set of stress-test results came out to much
less fanfare. In its
quarterly report on the health of individual banks and the banking industry
as a whole, Institutional Risk
Analytics (IRA), a respected financial services organization, found that the
stress levels among more than 7,500 FDIC-reporting banks nationwide had
risen dramatically. For 1,575 of the banks, net incomes had turned negative
due to decreased lending and less risk-taking.

The conclusion IRA drew was telling: "Our
overall observation is that US policy makers may very well have been
distracted by focusing on 19 large stress test banks designed to save Wall
Street and the world's central bank bondholders, this while a trend is
emerging of a going concern viability crash taking shape under the radar."
The report concluded with a question: "Has the time come to shift the policy
focus away from the things that we love, namely big zombie banks, to tackle
things that are truly hurting us?"

6. The bailout
encourages the very behaviors that created the economic crisis in the first
place instead of overhauling our broken financial system and helping the
individuals most affected by the crisis.

As Joseph Stiglitz explained in the New
York Times, one major cause of the economic crisis was bank
overleveraging. "Using relatively little capital of their own," he wrote,
banks "borrowed heavily to buy extremely risky real estate assets. In the
process, they used overly complex instruments like collateralized debt
obligations." Financial institutions engaged in overleveraging in pursuit of
the lucrative profits such deals promised--even if those profits came with
staggering levels of risk.

Sound familiar? It should, because in the
PPIP and TALF bailout programs the Treasury Department has essentially
replicated the very over-leveraged, risky, complex system that got us into
this mess in the first place: in other words, the government hopes to repair
our financial system by using the flawed practices that caused this crisis.

Then there are the institutions deemed
"too big to fail." These financial giants--among them AIG, Citigroup and
Bank of America-- have been kept afloat by billions of dollars in bottomless
bailout aid. Yet reinforcing the notion that any institution is "too big to
fail" is dangerous to the economy. When a company like AIG grows so large
that it becomes "too big to fail," the risk it carries is systemic, meaning
failure could drag down the entire economy. The government should force "too
big to fail" institutions to slim down to a safer, more modest size;
instead, the Treasury Department continues to subsidize these financial
giants, reinforcing their place in our economy.

Of even greater concern is the message the
bailout sends to banks and lenders--namely, that the risky investments that
crippled the economy are fair game in the future. After all, if banks fail
and teeter at the edge of collapse, the government promises to be there with
a taxpayer-funded, potentially profitable safety net.

The handling of the bailout makes at least
one thing clear, however. It's not your health that the government is
focused on, it's theirs-- the very banks and lenders whose convoluted
financial systems provided the underpinnings for staggering salaries and
bonuses, while bringing our economy to the brink of another Great
Depression.

Since last September, the government's case for
bailing out AIG has rested on the notion that the company was too big to
fail. If AIG hadn't been rescued, the argument goes, its credit default swap
(CDS) obligations would have caused huge losses to its counterparties—and
thus provoked a financial collapse.

Last week's news that this was not in fact the
motive for AIG's rescue has implications that go well beyond the Obama
administration's efforts to regulate CDSs and other derivatives. It's one
more example that the administration may be using the financial crisis as a
pretext to extend Washington's control of the financial sector.

The truth about the credit default swaps came out
last week in a report by TARP Special Inspector General Neil Barofsky. It
says that Treasury Secretary Tim Geithner, then president of the New York
Federal Reserve Bank, did not believe that the financial condition of AIG's
credit default swap counterparties was "a relevant factor" in the decision
to bail out the company. This contradicts the conventional assumption, never
denied by the Federal Reserve or the Treasury, that AIG's failure would have
had a devastating effect.

So why did the government rescue AIG? This has
never been clear.

The Obama administration has consistently argued
that the "interconnections" among financial companies made it necessary to
save AIG and Bear Stearns. Focusing on interconnections implies that the
failure of one large financial firm will cause debilitating losses at
others, and eventually a systemic breakdown. Apparently this was not true in
the case of AIG and its credit default swaps—which leaves open the question
of why the Fed, with the support of the Treasury, poured $180 billion into
AIG.

The broader question is whether the entire
regulatory regime proposed by the administration, and now being pushed
through Congress by Rep. Barney Frank and Sen. Chris Dodd, is based on a
faulty premise. The administration has consistently used the term "large,
complex and interconnected" to describe the nonbank financial institutions
it wants to regulate. The prospect that the failure of one of these firms
might pose a systemic risk is the foundation of the administration's
comprehensive regulatory regime for the financial industry.

Up to now, very few pundits or reporters have
questioned this logic. They have apparently been satisfied with the
explanation that the "interconnectedness" created by those mysterious credit
default swaps was the culprit.

But the New York Fed is the regulatory body most
familiar with the CDS market. If that agency did not believe AIG's failure
would have actually brought down its counterparties—and ultimately the
financial system itself—it raises serious questions about the
administration's credibility, and about the need for its regulatory
proposals. If "interconnections" among financial institutions are indeed the
source of the financial crisis, the administration should be far more
forthcoming than it has been about exactly what these interconnections are,
and how exactly a broad new system of regulation and resolution would
eliminate or reduce them.

The administration's unwillingness or inability to
clearly define the problem of interconnectedness is not the only weakness in
its rationale for imposing a whole new regulatory regime on the financial
system. Another example is the claim—made by Mr. Geithner and President
Obama himself—that predatory lending by mortgage brokers was one of the
causes of the financial crisis.

No doubt some deceptive practices occurred in
mortgage origination. But the facts suggest that the government's own
housing policies—and not weak regulation—were the source of these bad loans.

At the end of 2008, there were about 26 million
subprime and other nonprime mortgages in our financial system. Two-thirds of
these mortgages were on the balance sheets of the Federal Housing
Administration, Fannie Mae and Freddie Mac, and the four largest U.S. banks.
The banks were required to make these loans in order to gain approval from
the Fed and other regulators for mergers and expansions.

The fact that the government itself either bought
these bad loans or required them to be made shows that the most plausible
explanation for the large number of subprime loans in our economy is not a
lack of regulation at the mortgage origination level, but government-created
demand for these loans.

Finally, although there may be a good policy
argument for a new consumer protection agency for financial services and
products, the scope of what the administration has proposed goes far beyond
lending, or even deposit-taking. In the administration's proposed
legislation, the Consumer Financial Protection Agency would cover any
business that provides consumer credit of any kind, including the common
layaway plans and Christmas clubs that small retailers offer their
customers.

Under the guise of addressing the causes of a
global financial crisis, the Obama administration's bill would have
regulated credit counseling, educational courses on finance, financial-data
processing, money transmission and custodial services, and dozens more small
businesses that could not possibly cause a financial crisis. Even Chairmen
Frank and Dodd balked at this overreach. Their bills exempt retailers if
their financial activity is incidental to their other business. Still, many
vestiges of this excess remain in the legislation that is now being pushed
toward a vote.

The lack of candor about credit default swaps, the
effort to blame lack of regulation for the subprime crisis and the excessive
reach of the proposed consumer protection agency are all of a piece. The
administration seems to be using the specter of another financial crisis to
bring more and more of the economy under Washington's control.

With the help of large Democratic majorities in
Congress, this train has had considerable momentum. But perhaps—with the
disclosure about credit default swaps and the AIG crisis—the wheels are
finally coming off.

Two months ago, the “new”
General Motors made possible by government bailouts, theft of shareholders’
equity for forced re-distribution to unions, and managerial change at
government’s gunpoint, was held up as shining example of success – it was
even repaying its debt to Uncle Sam early.

But the week of the
Independence Day, GM announced its urgent need to borrow five billion
dollars, to use in re-paying debt (ie. paying its VISA bill with a new
MasterCard) and as cash reserves to counter anticipated slumping sales.

As Arte Johnson used to say
on “Laugh-In:” v-e-r-y interesting.

If you go to a movie set,
you will see perfect-looking streets, each building front rich in detail,
looking as real as real can be. Yet its only façade. One thin piece of
painted sheetrock propped up. Walk around behind it, there’s nothing there.

That’s GM. State pension
funds in 30-plus states people are counting on, upside down in toto by
trillions. Obama’s stimulus. There are signs stuck here or there with his
logo on them, proclaiming the dirt mound or torn up street his “stimulus at
work.” The sign-maker was stimulated. Who else? That’s this entire economy.
A façade. Walk around behind it: there’s nothing there. No real job
creation, no business investment, no real estate investment, nothing much
happening but very un-hopeful hoarding. Where has all the money gone?

There is flight of capital.
Companies like Ford and Microsoft moving hundreds of millions of dollars to
investments overseas. Mega-investors like Buffett are breaking
long-standing, self-imposed prohibition on investing in non-U.S. companies
in foreign lands. Insurers and health care companies are quietly buying up
land beyond our borders.

A major business story going
unreported: the long, long list of iconic American brand companies closing
countless stores, shops and restaurant locations here while expanding and
opening outlets like mad in other countries. That means they are draining
money out of local economies here and moving it over there. Starbucks.
Wal-Mart. Etc. Can’t you hear this giant sucking sound?

There is capital on strike.
An estimated $2-trillion of excess cash reserves in companies other than
financial institutions – although they are hoarding rather than lending,
too. And this is calculated from examining big, public companies. As
somebody intimately in touch with thousands of small business owners, I can
personally assure you, their reluctance to invest or spend is profound, and,
in aggregate, they are likely keeping trillions more inactive.

The ballyhooed IPO by GM has or soon will take
place. This is amazing inasmuch as General Motors transformed itself from a
solid, steady manufacturer with a clean reputation into a troubled U.S.
automaker and then into another twenty-first century accounting fraudster
before almost becoming another bankrupt has-been.

This Phoenix rises with the blessings of the White
House and now appears as a budding star, even though its accounting is as
clean as an 100,000 mile-engine whose oil has never been changed. I wondered
why the Obama administration tinkered with this bankruptcy the way it did
and wondered about the back room deals. But no longer—I have finally figured
out the relationship between GM and Washington.

The SEC flagged GM for accounting issues in 2006,
and the firm confessed to several accounting deficiencies that overstated
earnings by at least $2 billion. Further, it cited problems with its
internal control system, problems that have yet to be rectified four years
later! Its recent S-1 stated, “We have determined that our disclosure
controls and procedures and our internal control over financial reporting
are currently not effective. The lack of effective internal controls could
materially adversely affect our financial condition and ability to carry out
our business plan.” So, the firm that issued accounting lies to the
investment community over the last decade is getting ready to issue a ton of
stock with little assurance that the accounting numbers are worth the
electronic bits they’re written on. What a deal! But wait—there’s more.

General Motors, with the help of its auditor and
investment banker and the White House, discovered—make that created—positive
equity by recognizing a huge amount of accounting goodwill. Many observers
have booed the presence of this goodwill, as much of it is due to FASB’s
idiotic concept of writing down liabilities because of a firm’s own credit
risk. (The FASB needs to realize its role is setter of accounting standards,
not setter of financial analytic methods.) These arguments are all correct,
for the goodwill number is built on whims, at best. GM’s goodwill serves as
a wonderful example why goodwill is really not an asset. But wait—there’s
more.

General Motors faces gargantuan pension obligations
now and in the future. GM itself says in the S-1 that its unfunded
liabilities are around $37 billion, a number I expect to grow rapidly in the
next few years. I wonder why anybody would pay a premium for GM’s stock
given the extent of these pension debts. These liabilities did not get
reduced while GM was in bankruptcy, presumably as a result of the Faustian
deal it made with the White House. I presume the Obama administration did
this to avoid a huge stress on the PBGC if these pension obligations had
been relieved.

Recently we learned through a Wall Street Journal
report that the government allowed GM to keep its tax carryforwards even
though it went into corporate bankruptcy. Clearly, this adds value to GM but
not for the reason most pundits cite. Many marvel that GM’s future profits
will not get taxed for years to come, but I am less optimistic about GM’s
ability to generate future profits. As GM has not and cannot solve its
internal control problems and has not shown much ability to manufacture
anything efficiently over the long haul, I foresee losses in GM’s future.
But, these tax loss carryforwards might be valuable to others, assuming
there are no restrictions on their use by acquiring companies. If GM has
positive equity, it is primarily because somebody else can take advantage of
these carryforwards.

Place a barf bag in your lap before watching
these videos!
But are they accurate?
In June and July Goldman Sachs put up a pretty good defense.
Now I'm not so sure.

Questions
Why is the SEC still hiding the names of these tremendously lucky naked short
sellers in Bear Sterns and Lehman Bros.?
Was it because these lucky speculators were such good friends of Hank Paulson
and Timothy Geithner?
Or is Matt Taibbi himself a fraud as suggested last summer by Wall Street media
such as
Business Insider?

Jensen Comment
Evidence suggests that the SEC may be protecting these Wall Street thieves!
Or was all of this stealing perfectly legal? If so why the continued secrecy on
the part of the SEC?
Suspicion: The stealing may have taken place in top investors needed by
the government for bailout (Goldman Sachs?)

Now, off we go to Goldman Sachs' notorious lobbying
hubris, the historically-annotated, umpteenth oversight failure of the
Securities Exchange Commission ("SEC"), and what I'm quickly realizing may
well turnout to be the story with regard to it becoming the poster
child for regulatory capture and supervisory breakdown as far as our Wall
Street-based corporatocracy/oligarchy is concerned. Here's the link to
Taibbi's preview blog post: "An
Inside Look at How Goldman Sachs Lobbies the Senate."

Securities regulators are exploring new
regulations for the multitrillion-dollar securities-lending market, the
first major step regulators have taken in the area in decades.

Securities and Exchange Commission Chairman
Mary Schapiro said she wants to shine a light on the "opaque market."
After many large investors lost millions in last year's credit crunch,
she said, "we need to consider ways to enhance investor-oriented
oversight."

The SEC is holding a public round table Tuesday
to explore several issues around securities lending, which has expanded
into a big moneymaker for Wall Street firms and pension funds.
Regulation hasn't kept pace, some industry participants...

The SEC is holding a public round table Tuesday
to explore several issues around securities lending, which has expanded
into a big moneymaker for Wall Street firms and pension funds.
Regulation hasn't kept pace, some industry participants contend.
Securities lending is central to the practice of short selling, in which
investors borrow shares and sell them in a bet that the price will
decline. Short sellers later hope to buy back the shares at a lower
price and return them to the securities lender, booking a profit.
Lending and borrowing also help market makers keep stock trading
functioning smoothly.

--SNIP--

Later on this week I have a story coming out in
Rolling Stone that looks at the history of the Bear Stearns and Lehman
Brothers collapses. The story ends up being more about naked
short-selling and the role it played in those incidents than I had
originally planned -- when I first started looking at the story months
ago, I had some other issues in mind, but it turns out that there's no
way to talk about Bear and Lehman without going into the weeds of naked
short-selling, and to do that takes up a lot of magazine inches. So
among other things, this issue takes up a lot of space in the upcoming
story.

Naked short-selling is a kind of counterfeiting
scheme in which short-sellers sell shares of stock they either don't
have or won't deliver to the buyer. The piece gets into all of this, so
I won't repeat the full description in this space now. But as this week
goes on I'm going to be putting up on this site information I had to
leave out of the magazine article, as well as some more timely material
that I'm only just getting now.

Included in that last category is some of the
fallout from this week's SEC "round table" on the naked short-selling
issue.

The real significance of the naked
short-selling issue isn't so much the actual volume of the behavior,
i.e. the concrete effect it has on the market and on individual
companies -- and that has been significant, don't get me wrong -- but
the fact that the practice is absurdly widespread and takes place right
under the noses of the regulators, and really nothing is ever done about
it.

It's the conspicuousness of the crime that is
the issue here, and the degree to which the SEC and the other financial
regulators have proven themselves completely incapable of addressing the
issue seriously, constantly giving in to the demands of the major banks
to pare back (or shelf altogether) planned regulatory actions. There
probably isn't a better example of "regulatory capture," i.e. the
phenomenon of regulators being captives of the industry they ostensibly
regulate, than this issue.

Taibbi continues on to inform us that none of the
invited speakers to this government-sponsored event represented stockholders
or companies that could, or have, become targets/victims of naked
short-selling. Also "...no activists of any kind in favor of tougher rules
against the practice. Instead, all of the invitees are (were) either banks,
financial firms, or companies that sell stuff to the first two groups."

Taibbi then informs us that there is only one
panelist invited that's in favor of what may be, perhaps, the most basic
level of regulatory control with regard to this industry practice: a "simple
reform" called "pre-borrowing." Pre-borrowing requires short-sellers to
actually possess the stock shares before they're sold.

It's been proven to work, as last summer the SEC,
concerned about predatory naked short-selling of big companies in the
wake of the Bear Stearns wipeout, instituted a temporary pre-borrow
requirement for the shares of 19 fat cat companies (no other companies
were worth protecting, apparently). Naked shorting of those firms
dropped off almost completely during that time.

The lack of pre-borrow voices invited to this
panel is analogous to the Max Baucus health care round table last
spring, when no single-payer advocates were invited. So who will get to
speak? Two guys from Goldman Sachs, plus reps from Citigroup, Citadel (a
hedge fund that has done the occasional short sale, to put it gently),
Credit Suisse, NYSE Euronext, and so on.

Taibbi then tells us of increased efforts by
industry players, specifically noting Goldman Sachs being at the forefront
of this effort, and having "their presence felt."

Taibbi mentioned that he'd received two completely
separate calls from two congressional staffers from different offices--folks
whom Taibbi never met before--who felt compelled to inform him of Goldman's
actions.

We learn that these folks both commented on how
these Goldman folks were lobbying against restrictions on naked
short-selling. One of the aides told Taibbi that they had passed out a "fact
sheet about the issue that was so ridiculous that one of the other staffers
immediately thought to send it to me. "

I would later hear that Senate aides between
themselves had discussed Goldman's lobbying efforts and concluded that
it was one of the most shameless performances they'd ever seen from any
group of lobbyists, and that the "fact sheet" the company had had the
balls to hand to sitting U.S. Senators was, to quote one person familiar
with the situation, "disgraceful" and "hilarious."

Checkout the whole story on his blog. Apparently,
in the upcoming Rolling Stone piece, he gets into the nitty gritty with
regard to how naked short-selling brought down both Bear Stearns and Lehman,
last year.

Should be pretty powerful stuff.

Meanwhile, getting back to the SEC roundtable,
noted above, strike up the fifth item that I've now documented in the past
48 hours where it's becoming self-evident that our elected representatives
and our government agencies aren't even bothering to author the new
regulations and legislation that's so needed to prevent a recurrence of
events such as those we witnessed through the economic/market catastrophes
of the past 24 months; these legislators and high-ranking government
officials are actually having the lobbyists navigate the discussion and
write the damn stuff, too!

How much worse can it get? I really don't want
to know the answer to that rhetorical question. But, with the inmates
running the asylum, we may just find out sooner than we think!

Bailing Out Big Banks Engaged in Sleaze and Sex
"Goldman Laid Down with Dogs," by Ryan Chittum, Columbia Journalism
Review, November 4, 2009 ---
http://www.cjr.org/index.php
This link was forwarded by my friend Larry.

Dean Starkman has been applauding McClatchy’s
series on Goldman Sachs (an Audit funder) for
a couple of
days now. Add another Audit appreciation today.

McClatchy has been doing what Dean has been calling
for for a long time now: Looking much more closely at how Wall Street
fueled the mortgage crisis and how it was deeply connected
to the shadier parts of the
housing industry. Or as McClatchy’s Greg Gordon puts it:

… one of Wall Street’s proudest and most
prestigious firms helped create a market for junk mortgages,
contributing to the economic morass that’s cost millions of Americans
their jobs and their homes.

Today,
McClatchy examines Goldman’s relationshipwith New
Century Financial, a firm that was something of the canary in the coalmine
of this financial crisis—it was the second-biggest subprime mortgage lender
when it went belly-up in April 2007, which was very, very early. In other
words, it was one of the worst actors in the whole mess:

Perhaps no mortgage lender was more emblematic of
the go-go atmosphere in the sprouting industry that was seizing an
outsize share of the home loan market.

Traversing the country in private jets and
zipping around Southern California in Mercedes Benzes, Porsches and even
a Lamborghini, New Century executives reveled as the firm’s annual
residential mortgage sales rocketed from $357 million in 1996 to nearly
$60 billion a decade later…

What does that have to do with Goldman Sachs and
Wall Street?

For $100 million in mortgages, New Century could
command fees from Wall Street of $4 million to $11 million, ex-employees
told McClatchy. The goal was to close loans fast, bundle them into pools
and sell them to generate money for the next round.

Inside the mortgage company, the former
employees said, pressure was intense to increase the firm’s share of an
exploding market for mortgages that depended almost entirely on Wall
Street’s seemingly unlimited hunger for bigger, faster returns.

Aha! But wait—why did Wall Street want to buy this
trash?

Goldman and other investment banks could put $20
million in the till by taking a 1 percent fee for assembling,
securitizing and selling a $2 billion pool of mostly triple-A rated
bonds backed by subprime loans — and that was just stage one.

That takes you to “The
Giant Pool of Money.” And that was far from the
only juice being squeezed from these lemons. Goldman et al got servicing
fees and the like, plus they “extended lines of credit to New Century —
known as “warehouse loans” — totaling billions of dollars to finance the
issuance of more home loans to other marginal borrowers. Goldman Sachs’
mortgage subsidiary gave the firm a $450 million credit line.”

In other words, Wall Street lent the money to the
predatory firms to create the shady loans so it could buy them from them,
slice them into securities and sell them to the greater fools. This was so
profitable there weren’t enough decent loans to be made. So to feed the
beast, mortgage lenders came up with disastrous inventions like NINJA loans
(No Income, No Jobs, No Assets) and Wall Street, ahem, looked the other way.

It was a vicious circle of profit (virtuous—if you
were one of those who lined their pockets through it) and was interrupted
only when the underlying loans got so bad that borrowers like the ones with
no income, no jobs, and no assets in many instances couldn’t even make a
single payment on the loan. Panic!

McClatchy does well to report on the New Century
culture, helpful in illustrating the lie-down-with-dogs-get-up-with-fleas
thing, writing about the sexualization of some of the work, something
reminds us of BusinessWeek’s
fascinating story on the subprime
industry’s descent into decadence (the sub headline on that one should be
all that’s needed to entice you to read that one: “The sexual favors,
whistleblower intimidation, and routine fraud behind the fiasco that has
triggered the global financial crisis.”)

But it wasn’t just sex. New Century was giving
kickbacks to mortgage brokers to get their loans, McClatchy quotes a former
top underwriter there as saying.

Let’s not forget, and McClatchy doesn’t,
thankfully, that borrowers were the marks here and took it on the chin:

The loans laid out financial terms that protected
investors but punished homebuyers. They offered above-market interest
rates, typically starting at 8 percent, with provisions that Lee said
were “rigged” to guarantee the maximum 3 percent rise in interest rates
after two years and almost assuredly another 3 percent increase through
ensuing, twice-yearly adjustments.

Marvene is a poor and unemployed elderly woman who lost her shack to
foreclosure in 2008.
That's after Marvene stole over $100,000 when she refinanced her shack with a
subprime mortgage in 2007.
Marvene wants to steal some more or at least get her shack back for free.
Both the Executive and Congressional branches of the U.S. Government want to
give more to poor Marvene.
Why don't I feel the least bit sorry for poor Marvene?
Somehow I don't think she was the victim of unscrupulous mortgage brokers and
property value appraisers.
More than likely she was a co-conspirator in need of $75,000 just to pay
creditors bearing down in 2007.
She purchased the shack for $3,500 about 40 years ago ---
http://online.wsj.com/article/SB123093614987850083.html

Marvene Halterman, an unemployed Arizona woman with a
long history of creditors, took out a $103,000 mortgage on her 576
square-foot-house in 2007. Within a year she stopped making payments. Now the
investors with an interest in the house will likely recoup only $15,000.The Wall Street Journal slide show
of indoor and outdoor pictures ---
http://online.wsj.com/article/SB123093614987850083.html#articleTabs%3DslideshowJensen Comment
The $15,000 is mostly the value of the lot since at the time the mortgage was
granted the shack was virtually worthless even though corrupt mortgage brokers
and appraisers put a fraudulent value on the shack. Bob Jensen's threads on
these subprime mortgage frauds are at
http://www.trinity.edu/rjensen/2008Bailout.htm
Probably the most common type of fraud in the Savings and Loan debacle of the
1980s was real estate investment fraud. The same can be said of the 21st Century
subprime mortgage fraud. Welcome to fair value accounting that will soon have us
relying upon real estate appraisers to revalue business real estate on business
balance sheets ---
http://www.trinity.edu/rjensen/Theory01.htm#FairValue

CEO to his accountant: "What is our net earnings
this year?"
Accountant to CEO: "What net earnings figure do you want to report?"

The sad thing is that Lehman, AIG, CitiBank, Bear
Stearns, the Country Wide subsidiary of Bank America, Fannie Mae, Freddie
Mac, etc. bought these
subprime mortgages at face value and their Big 4 auditors supposedly
remained unaware of the millions upon millions of valuation frauds in the
investments. Does professionalism in auditing have a stronger stench since
Enron?Where were the big-time auditors? ---
http://www.trinity.edu/rjensen/2008Bailout.htm#AuditFirms

September 30, 1999

Fannie MaeEases
CreditTo Aid Mortgage
Lending

By STEVEN A. HOLMES

In a move that could help increase home
ownership rates among minorities and low-income consumers, theFannie
Mae Corporation is easing the credit requirements on loansthat
it will purchase from banks and other lenders.

The action, which will begin as a pilot
program involving 24 banks in 15 markets -- including the New York
metropolitan region -- will encourage those banks to extend home
mortgages to individuals whosecredit
is generally not good enough to qualify for conventional loans.Fannie
Mae officials say they hope to make it a nationwide program by next
spring.

Fannie Mae, the nation's biggest underwriter
of home mortgages, has beenunder
increasing pressure from theClinton
Administrationto
expand mortgage loans among low and moderate income people and felt
pressure from stock holders to maintain its phenomenal growth in
profits.

In addition, banks, thrift institutions and
mortgage companies have been pressing Fannie Mae to help them make more
loans to so-called subprime borrowers. These borrowers whose incomes,
credit ratings and savings are not good enough to qualify for
conventional loans, can only get loans from finance companies that
charge much higher interest rates -- anywhere from three to four
percentage points higher than conventional loans.

''Fannie Mae has expanded home ownership for
millions of families in the 1990's by reducing down payment
requirements,'' said Franklin D. Raines, Fannie Mae's chairman and chief
executive officer. ''Yet there remain too many borrowers whose credit is
just a notch below what our underwriting has required who have been
relegated to paying significantly higher mortgage rates in the so-called
subprime market.''
Demographic information on these borrowers is sketchy. But at least one
study indicates that 18 percent of the loans in the subprime market went
to black borrowers, compared to 5 per cent of loans in the conventional
loan market.

In moving, even tentatively, into this new
area of lending, Fannie Mae is taking on significantly more risk, which
may not pose any difficulties during flush economic times. But the
government-subsidized corporation may run into trouble in an economic
downturn, prompting a government rescue similar to that of the savings
and loan industry in the 1980's.

''From the perspective of many people, including me, this is another
thrift industry growing up around us,'' said Peter Wallison a resident
fellow at the Americ an Enterprise Institute.''If
they fail, the government will have to step up and bail them out the way
it stepped up and bailed out the thrift industry.''

Under Fannie Mae's pilot program, consumers
who qualify can secure a mortgage with an interest rate one percentage
point above that of a conventional, 30-year fixed rate mortgage of less
than $240,000 -- a rate that currently averages about 7.76 per cent. If
the borrower makes his or her monthly payments on time for two years,
the one percentage point premium is dropped.

Fannie Mae, the nation's biggest underwriter
of home mortgages, does not lend money directly to consumers. Instead,
it purchases loans that banks make on what is called the secondary mark
et. By expanding the type of loans that it will buy,Fannie
Mae is hoping to spur banks to make more loans to people with
less-than-stellar credit ratings.

The best place to begin reading about this 2008 Wall Street bailout is at
http://en.wikipedia.org/wiki/United_States_housing_bubble
It's important to understand how the housing bubble grew and then burst before even
thinking about understanding the bailouts to date and the pending bailouts still
tied up in Congress. Those who are accounting and finance geeks can get a lot
more out of the
Fannie Mae Website and in particular Fannie's Investor Relations site ---
http://www.fanniemae.com/ir/index.jhtml;jsessionid=5PA54Q3LN1BS5J2FQSISFGI?p=Investor+Relations
After previously being caught with accounting fraud for purposes of padding
executive bonuses, having to change auditors from KPMG to PwC (as mandated by
the government), and putting Dennis Beresford in charge of the Audit Committee,
Fannie made a monumental effort to use proper accounting and make full (really
too full) disclosures (but without mentioning Barney Frank by name).

Doctors, hospitals, medical labs, pharmaceutical companies, and medical
equipment dealers get taxpayer dollars by directly billing the Medicare and
Medicaid "programs." When farmers and agri-businesses get their government
checks they come from farm aid/subsidy "programs." There are countless U.S.
Government "programs" that divert taxpayer dollars into corporations annually.
Government diverts a lot of taxpayer dollars to K-12 schools and higher
education through a vast array of education and research "programs."

Sometimes a "program" merely entails government backing of loans in case a
company fails. This was the intent of the Fannie Mae and Freddie Mack
quasi-public corporations. As long as Fannie Mae and Freddie Mack could attract
equity capital and business loans, cash from taxpayers was not necessary. But if
Fannie and Freddie should be on the verge of bankruptcy, loans were in most
cases backed by the U.S. Government and might have to be paid off with taxpayer dollars.
In the case of Fannie and Freddie at the moment, however, there is almost no chance of
having the government pay off troublesome debts and then let Fannie and Freddie try
to continue on their own. Equity shareholders lost their money in Fannie/Freddie
common stock and are not about to invest in
corporations that suddenly have little hope for profits because of Congressional
mandates to lend billions to people who have little chance to pay off their
mortgages owned by Fannie and Freddie.

A one-time government intervention to save a failing company is generally
called a "bailout" instead of a "program." Government intervention can take on a
wide range of forms. In some instances, a government may lend a failing business
cash with an expectation that the loan will be repaid, possibly with interest.
In some instances the government may also insist on options for equity share
ownership in the bailed out company. In other instances the government will
provide a gift in the form of a grant and may or may not receive benefits in
return. For example, government may have an interest in the results of a
research grant that initially is little more than a bailout gift. If Bath Iron
Works was on the verge of bankruptcy, the government would probably give it
contracts for new Navy ships. The military does not want most of its major
suppliers to fail.

Probably the most interesting and successful bailout in history was the U.S.
Government bailout of Chrysler Corporation in 1979.

The Chrysler Corporation on September 7,
1979 petitioned the United States government for US$1.5 billion in loan
guarantees to avoid bankruptcy. At the same time former Ford executive Lee
Iacocca was brought in as CEO. He proved to be a capable public spokesman,
appearing in advertisements to advise customers that "If you find a better
car, buy it." He would also provide a rallying point for Japan-bashing and
instilling pride in American products. His book Talking Straight was a
response to Akio Morita's Made in Japan.

The United States Congress reluctantly
passed the "Chrysler Corporation Loan Guarantee Act of 1979" (Public Law
96-185) on December 20, 1979 (signed into law by President Jimmy Carter on
January 7, 1980), prodded by Chrysler workers and dealers in every
Congressional district who feared the loss of their livelihoods. The
military then bought thousands of Dodge pickup trucks which entered military
service as the Commercial Utility Cargo Vehicle M-880 Series. With such help
and a few innovative cars (such as the K-car platform), especially the
invention of the minivan concept, Chrysler avoided bankruptcy and slowly
recovered.

In February 1982 Chrysler announced the
sale of Chrysler Defense, its profitable defense subsidiary to General
Dynamics for US$348.5 million. The sale was completed in March 1982 for the
revised figure of US$336.1 million.[7]

By the early 1980s, the loans were being
repaid at a brisk pace and new models based on the K-car platform were
selling well. A joint venture with Mitsubishi called Diamond Star Motors
strengthened the company's hand in the small car market. Chrysler acquired
American Motors Corporation (AMC) in 1987, primarily for its Jeep brand,
although the failing Eagle Premier would be the basis for the Chrysler LH
platform sedans. This bolstered the firm, although Chrysler was still the
weakest of the Big Three.

Another significant aspect of Chrysler's
recovery was the revitalization of the company's manufacturing facilities,
led by Richard Dauch[citation needed]. The factories were streamlined with
more efficient machinery, more robots, better paint equipment, and so
on[vague][citation needed]. The resultant improvements in efficiency and
vehicle quality played a big role in saving the company.

In the early 1990s, Chrysler made its
first steps back into Europe, setting up car production in Austria, and
beginning right hand drive manufacture of certain Jeep models in a 1993
return to the UK market. The continuing popularity of Jeep, bold new models
for the domestic market such as the Dodge Ram pickup, Dodge Viper (badged as
"Chrysler Viper" in Europe) sports car, and Plymouth Prowler hot rod, and
new "cab forward" front-wheel drive LH sedans put the company in a strong
position as the decade waned.

In other words, Chrysler in the 1960s and 1970s borrowed from Paul to
build cars, sold those cars, and used the sales revenues to pay back Paul.
Paul in turn loaned more money to build cars. In the late 1970s Chrysler
fell on hard times when its huge inventory of cars was building up like
bubble about to burst. There were all sorts of problems including the fact
that Chrysler vehicles were inferior to Japanese vehicles, especially the
long-lasting Toyota automobiles. Chrysler cars had notoriously bad gas
mileage.

The bottom line in 1979 was that Chrysler could not pay off its $1.5
billion loan from Paul on schedule. It tried to borrow money from Peter to
pay Paul, but Peter studied Chrysler's operation and refused to lend money
because Chrysler would bound up in too much fixed cost for building cars
that were inferior to Toyotas.

Such bailouts of business firms are not common in U.S. history. In the
case of Chrysler, the government was persuaded that too many people would be
thrown out of work, too many lenders would not be repaid, and too many
pensions funds and college endowments would be badly harmed if Chrysler went out of business. But
the bailout was not cash lending from taxpayers

Peter was most happy to lend money to Chrysler when the U.S. Government
cosigned the notes. But the government wisely put some conditions on
Chrysler before it cosigned the notes. Firstly, Chrysler had to
substantially reduce its fixed costs. Doing so was painful, but Chrysler
lived up to its bargain, closed some manufacturing plants, reduced executive
salaries, outsourced more of its component manufacturing, and terminated
many high-salaried autoworkers and managers. As I recall off the top of my
head, Chrysler reduced its annual fixed costs of over $4 billion to less
than $3 billion. For decades managerial accounting professors have shown how
changed "operating leverage" from both reduced fixed and variable costs
greatly lower the breakeven point as to how much revenue has to be earned to
recover fixed costs and begin to make a profit on each unit sold. Chrysler
really lowered its breakeven sales amount.

Another condition of the bailout was to the effect that the government
got equity ownership options if and when Chrysler turned itself around. In
effect, taxpayers could profit in Chrysler's good fortunes after the
bailout. There was of course risk that Chrysler would still fail and the
cosigner on the notes would have to pay Peter off with taxpayer funds. But
as luck would have it, Chrysler designed the K-car and CEO Lee Iacocca (who
could sell refrigerators to Eskimos) convinced the public that the K-car was
as good or better than a Toyota and was "American Made." Also Chrysler
successfully expanded its Jeep sales in the U.S. and overseas.

The bottom line is that Chrysler did recover in the 1980s, the
government did not have to pay Peter, and the government was in a position
to exercise its stock options and return a handsome profit to Chrysler. But
Chrysler managers and employees and shareholders pleaded with the government
not to exercise its stock options.

Congress passed the bill 21 December 1979,
but with strings attached. Congress required
Chrysler to obtain private financing for $1.5 billion -- the government
was co-signing the note, not printing the money -- and to obtain another
$2 billion in "commitments or concessions [that] can be arranged by
Chrysler for the financing of its operations." One of those options, of
course, was reduce employees wages; in prior discussions, the union had
failed to budge, but the contingent guarantee moved the union. On 7
January 1980,
Carter signedthe legislation (Public Law
86-185):

(Liberal) Economist
John Kenneth Galbraith suggestedthat taxpayers be "accorded an
appropriate equity or ownership position" for the loan. "This is thought
a reasonable claim by people who are putting up capital."

Under the leadership of Lee Iacocca,
Chrysler doubled its corporate average miles-per-gallon (CAFE). In 1978,
Chrysler introduced the first domestically produced front-wheel drive
small cars: the Dodge Omni and Plymouth Horizon.

The problem in 2008 with AIG, and the huge Wall Street firms like
Bear Stearns, Lehman, Merrill
Lynch, and the others now desperate for liquidity, is that they financed their
long-term mortgage investment portfolios with short term borrowing from Paul
that is now due. Paul refuses to extend the payment maturities, and Peter will
not loan the money to these giants desperate to pay off Paul and stave off
bankruptcy. How they got into this mess is complicated, but the bottom line is
that de-regulation in the Ronald Reagan era allowed these investment companies
to become commercial banks and vice versa. As such they could use short-term
demand deposits from Paul to finance long-term investments like mortgages
purchased from local banks who participated in the sub-prime frauds to make home
loans to people who could not possibly afford to make the payments once the low
starting rates kicked up to higher rates.

So where does AIG's bailout money go?
Remember that AIG, unlike Bear Stearns, Lehman Brothers, and Merrill Lynch, is
primarily an insurance company. As such it entered into heavy
credit default swaps which are derivative financial instruments that protect
against a swap counterparties bad debt losses due to customers' credit
downgrades. For example, if the counterparty holds fixed rate investments such
that values plunge if the customer's credit rating plunges, the counter parties
receive swap payments based the decline in the value of the debt that is
defaulted. Credit default swaps are virtual insurance policies protecting
against a default under the debt instrument. However, because the the debt
itself can be virtual (i.e., no real default loss transpires), counterparties
can speculate using credit default swaps. And unlike insurance contracts, credit
default swaps until very recently are unregulated.

The three firms that dominate the $5 billion-a-year
credit rating industry - Standard & Poor's, Moody's Investors Service and Fitch
Ratings - have been faulted for failing to identify risks in subprime mortgage
investments, whose collapse helped set off the global financial crisis. The
rating agencies had to downgrade thousands of securities backed by mortgages as
home-loan delinquencies have soared and the value of those investments
plummeted. The downgrades have contributed to hundreds of billions in losses and
writedowns at major banks and investment firms. The agencies are crucial
financial gatekeepers, issuing ratings on the creditworthiness of public
companies and securities. Their grades can be key factors in determining a
company's ability to raise or borrow money, and at what cost which securities
will be purchased by banks, mutual funds, state pension funds or local
governments. A yearlong review by the SEC, which issued the results last summer,
found that the three big (credit rating) agencies failed to rein in conflicts of
interest in giving high ratings to risky securities backed by subprime
mortgages.
"SEC Puts Off Vote on Rules for Rating Agencies," AccountingWeb, November
19, 2008 ---
http://accounting.smartpros.com/x63855.xml

In Florida, Lehman Brothers was an icon of finance
and real estate, managing public assets, selling securities, underwriting
bond deals and handling residential and commercial mortgages.

In the last decade, Florida paid Lehman at least
$27 million in fees for managing public investments and brokering and
underwriting bond deals.

The storied bank hired former Gov. Jeb Bush as a
consultant in June 2007, five months after he left office. As governor, Bush
also served as a trustee for the State Board of Administration, which
invests public money.

Lehman was the dominant Wall Street broker that
sold the SBA $1.4 billion of risky, mortgage-related securities that started
tanking in August 2007.

Bush has said he had nothing to do with those
sales.

"As Governor Bush has stated several times in
response to your inquiries, his role as a consultant to Lehman Brothers was
in no way related to any Florida investments,'' said his spokeswoman, Kristy
Campbell.

"It is unfortunate the St. Petersburg Times
continues to perpetuate this incorrect and baseless conjecture.''

If federal regulators and political
leaders want to earn back some trust, they could do two things. First, they
could provide us with some transparency about whom precisely we are backing
in the recent bailouts.

Take, for example, the rescue on Tuesday
of the American International Group, once the world’s largest insurance
company. It was pretty breathtaking. Since when do insurance companies,
whose business models seem to consist of taking in premiums and stonewalling
claims, deserve rescues from beleaguered taxpayers?

Answer: Ever since the world became
so intertwined that the failure of one company can topple a host of others.
And ever since
credit default swaps, those unregulated derivative
contracts that allow investors to bet on a debt issuer’s financial
prospects, loomed so big on balance sheets that they now drive every bailout
decision.

The deal to save A.I.G. involves a
two-year, $85 billion loan from taxpayers. In exchange, the new owners — us
— get 80 percent of the company. If enough of A.I.G.’s assets are sold for
good prices, we may get our money back.

Credit default swaps, which operate like
insurance policies against the possibility that an issuer of debt will not
pay on its obligations, were the single biggest motivator behind the A.I.G.
deal.

A.I.G. had written $441 billion in credit
insurance on mortgage-related securities whose values have declined; if
A.I.G. were to fail, all the institutions that bought the insurance would
have been subject to enormous losses. The ripple effect could have turned
into a tsunami.

So, the $85 billion loan to A.I.G. was
really a bailout of the company’s counterparties or trading partners.

Now, inquiring minds want to know, whom
did we rescue? Which large, wealthy financial institutions — counterparties
to A.I.G.’s derivatives contracts — benefited from the taxpayers’ $85
billion loan? Were their representatives involved in the talks that resulted
in the last-minute loan?

And did Lehman Brothers not get bailed out
because those favored institutions were not on the hook if it failed?

We’ll probably never know the answers to
these troubling questions. But by keeping taxpayers in the dark, regulators
continue to earn our mistrust. As long as we are not told whom we have
bailed out, we will be justified in suspecting that a favored few are making
gains on our dimes.

A.I.G.’s financial statements provided a
clue to the identities of some of its credit default swap counterparties.
The company said that almost three-quarters of the $441 billion it had
written on soured mortgage securities was bought by European banks. The
banks bought the insurance to reduce the amounts of capital they were
required by regulators to set aside to cover future losses.

Enjoy the absurdity: Billions in
unregulated derivatives that were about to take down the insurance company
that sold them were bought by banks to get around their regulatory capital
requirements intended to rein in risk.

Got that?

Which brings us to Item 2 for policy
makers. Stop pretending that the $62 trillion market for credit default
swaps does not need regulatory oversight.
Warren E. Buffett was not engaging in hyperbole
when he called these things financial weapons of mass destruction.

“The last eight years have been
about permitting derivatives to explode, knowing they were unregulated,”
said
Eric R. Dinallo, New York’s superintendent of
insurance. “It’s about what the government chose not to regulate, measured
in dollars. And that is what shook the world.”

These Main Street lenders also lied about the values of the homes
that they knew were appraised way above what could be recovered in foreclosures.
Although I think Wall Street's infectious greed was a huge part of the sub-prime
frauds, the roots of the deception are firmly planted along Main Street USA
(e.g., Countrywide
Financial, a subsidiary of Bank of America) where local lenders passed on (fenced?) fraudulent
loans all the way up the mortgage system.

Many Main Street borrowers themselves who signed sub-prime mortgages, at
almost no down payments, knew full well that for a short while they could make
payments at the early subprime teaser interest rates. But they also knew full
well that they could not sustain mortgage payments once the higher rates kicked
in on their mortgage contracts. But their plan was to sell the house when the
higher interest rates kicked in and profit from the increase in home values
while they paid on the basis of the teaser rates. The flaw was their assumption
that housing values just keep increasing like they did since the end of World
War II. These buyers never counted on the bursting of the sub-prime real
estate bubble.

Congress has
not yet agreed to the additional $700 billion bailout of other big Wall Street investment
banks, and how far it will go is yet to be decided in, gasp, Congress. The
government did bail out AIG. The 2008 bail out of AIG has hope for taxpayers
that was similar to the hope for Chrysler in 1979. The U.S. Government is
loaning the AIG enormous insurance conglomerate $85 billion with an option to
acquire ownership of 80% of AIG if and when AIG's fortunes are turned around.
Since AIG is so enormous globally, I predict this could be
a very good deal for taxpayers unless our idiotic Congress fails to resell its
AIG shares and attempts to turn the insurance industry into a Fannie Mae fiasco.

Now we come to the 2008 additional proposed bailouts of more banks and
investment banks across the nation borrowed from Paul to buy the same fraudulent
sub-prime mortgages from thousands of local banks around the nation. Many
homeowners at all levels of income and home values cannot possibly pay off these
mortgages. Foreclosures will only return half or less of what Fannie, Freddie,
and the Men in Black on Wall Street paid for the fraudulent mortgages. There's
still much debate on how much mortgage buying conglomerates knew about the
frauds perpetrated on Main Street that were passed on to Fannie, Freddie, and
Wall Street. Most of this is bullshit!See how it really worked (hit the arrow keys to move forward or
backward) ---
Click Here

The Men in Black on Wall Street knew full well that their sub-prime
mortgages, purchased with short-term debt, had loan values well in excess of
mortgage collateral (due to phony real estate appraisals on Main Street) and
were likely to become non-performing when the cheap starting sub-prime interest
rates kicked up to very high interest rates that made payments well in excess of
what many buyers could afford. The problem is that the Men in Black were too
greedy to care about risks imposed on their own investment banks. Like drug
dealers who cut cocaine bags into crack, the Men in Black cut fraudulent
sub-prime mortgages that they purchased into
CDOs
(collateralized debt obligations) that they then sold for huge
commissions/bonuses to unsuspecting investors (many from across the Atlantic and
Pacific).

In the current environment, I am an ardent supporter of
those who would resist calls to suspend fair value accounting rules. But, when I
was at the SEC, I had a front-row seat on what was perhaps one of the most
brazen abuses of fair value accounting in history. I was reminded of it by
Joseph Stiglitz's recent commentary on CNN.com, in which he
characterizedthe mortgage securitization craze as
just another pyramid scheme. Keep that in mind as I tell you the story of
Stephen Hoffenberg's$400 million fraud. Tom Selling, "The Anti-Fair Value
Lobby Has a Point (Even if They Don't Know It)" The Accounting Onion,
September 22, 2008 ---
http://accountingonion.typepad.com/

The greedy, greedy, greedy Men in Black (read that Wall Street bankers) got
their CDO sales commissions/bonuses with no regard that those sales were with
recourse such that when the loans defaulted, the fraudulent loans would
eventually become "junk" or "trash" paper bought back by their employers such as
Bear Stearns, AIG, Lehman, Merrill Lynch, etc. In other
words the Men in Black got their CDO sales
commissions knowing full well shareholders in their banks would ultimately take
a huge hit!!!

Bankers
(Men in Black) bet with their
bank's capital, not their own. If the bet goes right, they get a
huge bonus; if it misfires, that's the shareholders' problem.Sebastian Mallaby. Council on Foreign Relations, as
quoted by Avital Louria Hahn, "Missing: How Poor Risk-Management
Techniques Contributed to the Subprime Mess," CFO Magazine,
March 2008, Page 53 ---
http://www.cfo.com/article.cfm/10755469/c_10788146?f=magazine_featuredNow that the
Government is going to bail out these speculators with taxpayer funds
makes it all the worse.

Peter Pan, the manager of Countrywide Financial on Main Street, thought he had
little to lose by selling a fraudulent mortgage to Wall Street. Foreclosures
would be Wall Street’s problems and not his local bank’s problems. And he got
his nice little commission on the sale of the Emma Nobody’s mortgage for
$180,000 on a house worth less than $100,000 in foreclosure. And foreclosure was
almost certain in Emma’s case because she only makes $12,000 waitressing at the
Country Café. So what if Peter Pan fudged her income a mite in the loan
application along with the fudged home appraisal value? Let Wall Street or Fat
Fannie or Foolish Freddie worry about Emma after closing the pre-approved
mortgage sale deal. The ultimate loss, so thinks Peter Pan, will be spread over
millions of wealthy shareholders of Wall Street investment banks. Peter Pan is
more concerned with his own conventional mortgage on his precious house just two
blocks south of Main Street. This is what happens when risk is
spread even farther than Tinkerbell can fly! For details see
http://papers.nber.org/papers/w14358Read about the extent of cheating, sleaze, and subprime
sex on Main Street inAppendix U.

At the moment the initial 2008 Treasury Department bailout plan does not have
conditions anywhere close to the 1979 bailout plan for Chrysler --- which in
many ways were punitive conditions that made Chrysler pay dearly for past
mistakes. In fact the 2008 bailout initially proposed by the Treasury Department
to Congress only entails buying up paper trash owned by the Men in Black from
Wall Street for $700 billion --- way above the recycled worth of the trash.
There were no other conditions in the initial bailout proposal. The Men in Black
who dealt in this trash on Wall Street would still get their millions in
compensation in some form or another. Many of them would stay in the business of
inventing newer types of creative trash that they could foist on investors at
enormous commissions. Along the way they will do some good by inventing creative
financing that brings us such good companies as Google.

Here are some of some of the unmentioned problems in the Treasury Department
bailout plan of 2008 that were not part of the 1979 Chrysler bailout"

After the 2008 bailout was first proposed, the media and Congress jumped
on the wrong concerns such as the fairness issue of multimillion bailout
rewards to Men in Black who got us into this mess. Concerns are also being
raised that the poor people on Main Street who lost or are losing their
homes are not being compensated. Little mention is made that the people
losing their homes probably put nothing or very little into the homes since
the sub-prime mortgage deals being offered entailed little or no down
payments.

At the moment in the Autumn of 2008 both the media and Congress are not
looking closely enough into the "trash" or "junk" that the Men in Black are
trying to sell (foist is a better word) to the U.S. Government at values no
doubt much greater than a true fair value --- value that cannot really be
determined in this busted real estate market.

Ignoring
the more complex derivative financial instruments losers, other "junkers"
are trash paper mortgages on non-performing or under-performing mortgage
investments. A non-performing piece of paper is typically collateral on a
vacant foreclosed house and its lot. Perhaps the loan was for $300,000 on
property that is not selling at the moment for $150,000. These collateral
values and foreclosure prices range across the board, but in the case of a
$300,000 loan the Men in Black will probably negotiate a bailout price of
something like $150,000 or maybe even somewhat less. Now that sounds like a
possibly good deal if the Treasury Department can wait it out until the real
estate market recovers a bit and the property can be sold for more than the
bailout price.

But even really bad accountants know better in the case of real estate and
horses!

At the moment Congress is not proposing to look closely enough into the
mouth of each horse it will be buying in the bailout. In the case of a
purchased horse the buyer has to feed it, shelter it, pay the veterinarian
bills and tie up money invested. In the case of the bailout "trash paper,"
the Men in Black are darned tired of having to pay the bills on foreclosed
real estate --- the lawyer fees, the property taxes, the casualty insurance
premiums, and the maintenance bills for security, repairs, pest control,
lawn mowing, pool cleaning, and on and on and on. And don't forget the time
value of money lost if $150,000 in cash is tied up for ten years at zero
interest.

I think the reason the Men in Black are so willing to sell their trash
at discount (call that bailout) prices is that they're smarter than the
media and Congress. The Men in Black suspect they will otherwise have to
give the foreclosed properties away just to get out of all the dreaded home
ownership costs.

What I fear is that, if the Men in Black are willing to forego a year's
salary or 90% of their severance pay, our naive Congress will take the
Treasury Department's bailout deal. Obama makes a big deal about how many
houses John McCain now owns. Ha! Either Barack Obama or John McCain will
soon have to start paying the ownership costs of 5 million empty houses. The
only thing to do with these burdens will be one of the following:

(1) pay years and years of losing ownership costs until offers are received
somewhere close to bailout prices (probably the McCain solution since with a
rich wife he personally does not pay attention to interim home ownership
costs) or

(2) unload
the houses at way below bailout prices so that taxpayers lose big time or

(3) give the vacant houses to poor people (probably the Obama populist
solution).

But there's a downside to giving the foreclosed empty houses to poor
people. Most poor people probably cannot afford to pay the property taxes
and the other costs of home ownership. They will sell their magnificent gift
houses for whatever they can get, have some really good times afforded from
the proceeds, and then go back into public housing or apply for rent
subsidies. So much for populism that only brings on a few days of good
times.

In a bailout purchase of trash paper be careful of what you wish for ---
you may get what you wished for.
The concept of
loan collateral used to mean that the collateral had greater value then the
amount loaned --- so that, in case of default, the collateral would cover
the loan. The roots of this crisis lie in the loans made by mortgage lenders
on Main Street (e.g., Bank of America’s Countrywide Finance that made loans
at phony collateral values when the actual collateral values were way less
than the loan amounts).

The magnitude of the ultimate loss to taxpayers is likely to be much
less unless the bailout fails to keep the economy out a deep depression
and/or Congress tinkers with the bailout to make it an opportunity to make a
populist wealth transfer from taxpayers to non-taxpayers.

Still, we have to consider potential risks
of these governmental actions. Taxpayers may be stuck with hundreds of
billions, and perhaps more than a trillion, dollars of losses from the
various insurance and other government commitments. Although the media
has nade much of this possibility through headlines like "$750 billion
bailout", that magnitude of loss is highly unlikely as long as the
economy does not fall into a sustained major depression. I consider such
a depression highly unlikely. Indeed, the government may well make money
on its actions, just as the Resolution Trust Corporation that took over
many saving and loan banks during the 1980s crisis did not lose much, if
any, money. By buying assets when they are depressed and waiting out the
crisis, there may be a profit on these assets when they are finally sold
back to the private sector. Making money does not mean the government
involvements were wise, but the likely losses to taxpayers are being
greatly exaggerated. Future moral hazards created by these actions are
certainly worrisome. On the one hand, the equity of stockholders and of
management in Fannie and Freddie, Bears Stern, AIG, and Lehman Brothers
have been almost completely wiped out, so they were not spared major
losses. On the other hand, that makes it difficult to raise additional
equity for companies in trouble because suppliers of equity would expect
their capital to be wiped out in any future forced governmental
assistance program. Furthermore, that bondholders in Bears Stern and
these other companies were almost completely protected implies that
future financing will be biased toward bonds and away from equities
since bondholders will expect protections against governmental responses
to future adversities that are not available to equity participants.
Although the government was apparently concerned that foreign central
banks were major holders of the bonds of the Freddies, I believe it was
unwise to give them and other bondholders such full protection.
Nobel Laureate Gary Becker, The Becker-Posner Blog, September 21,
2008 ---
http://www.becker-posner-blog.com/

Jensen Comment
I think this is baloney, because Becker does not factor in the cost of
"ownership" of millions of empty houses acquired in the bailout. This
will destroy the opportunity to recover what the bad debts in the
bailout's reverse auction initially cost the government. The real
problem is the subsequent costs added to the auctioned costs.

Unregulated investment banking on a large scale has probably ended in
2008 --- See Appendix D of this paper.

Real Estate Nobody WantsSharon Little says she was shocked to find out she was
still listed as the owner of a rental property on a busy Cleveland street. She
walked away from the house in 2006 when she declared bankruptcy. Since then,
thieves have stripped the house of siding, copper plumbing, and even windows.
She found out her name was still on the deed only when she got a summons last
October to appear in housing court. "Eventually, they're going to tear this
house down," Little says. "Somebody's going to have to foot the bill, and
frankly I think it should be the bank because it's their house. It's not my
house really, so ..." Mhari Saito, "Banks Refusing to Take
Back Foreclosed Properties," NPR, March 8, 2009 ---
http://www.npr.org/templates/story/story.php?storyId=101386052
Jensen Comment
The former owner doesn't want the property. The mortgage holder forgave the loan
but does not want title to the foreclosed property. The city by all rights
should take title to the property for back taxes, but the city knows nobody will
even pay the back taxes on the property. These properties are like hazardous
waste sites without the hazardous wastes. It's simply that the value of the
property is less than the cost of property taxes, maintenance, and insurance
with no improvement in the property's value in sight.

That some bankers have ended up in prison is not a matter of
scandal, but what is outrageous is the fact that all the others are
free.
Honoré de Balzac

The bourgeoisie can
be termed as any group of people who are discontented with what they
have, but satisfied with what they are
Nicolás Dávila

There are dozens of books on the financial crisis: I
have read many of them and the Kindle samples for just about all of them.
There are only two I would recommend: those are Bethany McLean and Joe
Nocera’s excellent
All the Devils are Hereand the much more
specifically detailed Fatal Risk from
Roddy Boyd. Roddy's book is solely concerned with the failure of AIG.

Both books start without any strong ideological preconceptions and let the
facts woven into a good story do the talking - and both wind up ambivalent
about many of the major players - with many players having human weaknesses
(gullibility, delusion, arrogance etc) but committing nothing that looks
like a strong case for criminal prosecution. Reading these you can see why
there are so few criminal prosecutions from the crisis. And you will also
see just how extreme the human failings that caused the crisis are.

At that same bank, executives checking for
fraudulent mortgage applications found that at one bank office 42 percent of
loans reviewed showed signs of fraud, “virtually all of it attributable to
some sort of employee malfeasance or failure to execute company policy.” A
report recommended “firm action” against the employees involved.

In addition to such internal foresight and
vigilance, that bank had regulators who spotted problems with procedures and
policies. “The regulators on the ground understood the issues and raised
them repeatedly,” recalled a retired bank official this week.

This is not, however, a column about a bank that
got things right. It is about Washington Mutual, which in 2008 became the
largest bank failure in American history.

What went wrong? The chief executive, Kerry K.
Killinger, talked about a bubble but was also convinced that Wall Street
would reward the bank for taking on more risk. He kept on doing so, amassing
what proved to be an almost unbelievably bad book of mortgage loans. Nothing
was done about the office where fraud seemed rampant.

The regulators “on the ground” saw problems, as
James G. Vanasek, the bank’s former chief risk officer, told me, but the
ones in Washington saw their job as protecting a “client” and took no
effective action. The bank promised change, but did not deliver. It
installed programs to spot fraud, and then failed to use them. The board
told management to fix problems but never followed up.

WaMu, as the bank was known, is back in the news
because the Federal Deposit Insurance Corporation sued Mr. Killinger and two
other former top officials of the bank last week, seeking to “hold these
three highly paid senior executives, who were chiefly responsible for WaMu’s
higher-risk home-lending program, accountable for the resulting losses.”

Mr. Killinger responded by going on the attack. His
lawyers called the suit “baseless and unworthy of the government.” Mr.
Killinger, they said, deserved praise for his excellent management.

I’ll let the courts sort out whether Mr. Killinger
will become the rare banker to be penalized for making disastrously bad
loans. But I am fascinated by how his bank came to make those loans despite
his foresight.

Answers are available, or at least suggested, in
the mass of documents collected and released by the Senate Permanent
Subcommittee on Investigations, which held hearings on WaMu last year. Mr.
Killinger wanted both the loan book and profits to rise rapidly, and saw
risky loans as a means to those ends.

Moreover, this was a market in which a bank that
did not reduce lending standards would lose a lot of business. A decision to
publicly decry the spread of high-risk lending and walk away from it —
something Mr. Vanasek proposed before he retired at the end of 2005 — might
have saved the bank in the long run. In the short run, it would have
devastated profits.

Ronald J. Cathcart, who became the chief risk
officer in 2006, told a Senate hearing he pushed for more controls but ran
into resistance. The bank’s directors, he said, were interested in hearing
about problems that regulators identified over and over again. “But,” he
added, “there was little consequence to these problems not being fixed.”

There were consequences for him. He was fired in
2008 after he took his concerns about weak controls and rising losses to
both the board and to regulators from the Office of Thrift Supervision.

By early 2007, the subprime mortgage market was
collapsing, and the bank was trying to rush out securitizations before that
market vanished. The Federal Deposit Insurance Corporation, a secondary
regulator, was pushing to impose tighter regulation, but the primary
regulator, the Office of Thrift Supervision, was successfully resisting
allowing the F.D.I.C. to even look at the bank’s loan files.

Place a barf bag in your lap before watching
these videos!
But are they accurate?
In June and July Goldman Sachs put up a pretty good defense.
Now I'm not so sure.

Questions
Why is the SEC still hiding the names of these tremendously lucky naked short
sellers in Bear Sterns and Lehman Bros.?
Was it because these lucky speculators were such good friends of Hank Paulson
and Timothy Geithner?
Or is Matt Taibbi himself a fraud as suggested last summer by Wall Street media
such as
Business Insider?

Jensen Comment
Evidence suggests that the SEC may be protecting these Wall Street thieves!
Or was all of this stealing perfectly legal? If so why the continued secrecy on
the part of the SEC?
Suspicion: The stealing may have taken place in top investors needed by
the government for bailout (Goldman Sachs?)

Now, off we go to Goldman Sachs' notorious lobbying
hubris, the historically-annotated, umpteenth oversight failure of the
Securities Exchange Commission ("SEC"), and what I'm quickly realizing may
well turnout to be the story with regard to it becoming the poster
child for regulatory capture and supervisory breakdown as far as our Wall
Street-based corporatocracy/oligarchy is concerned. Here's the link to
Taibbi's preview blog post: "An
Inside Look at How Goldman Sachs Lobbies the Senate."

Securities regulators are exploring new
regulations for the multitrillion-dollar securities-lending market, the
first major step regulators have taken in the area in decades.

Securities and Exchange Commission Chairman
Mary Schapiro said she wants to shine a light on the "opaque market."
After many large investors lost millions in last year's credit crunch,
she said, "we need to consider ways to enhance investor-oriented
oversight."

The SEC is holding a public round table Tuesday
to explore several issues around securities lending, which has expanded
into a big moneymaker for Wall Street firms and pension funds.
Regulation hasn't kept pace, some industry participants...

The SEC is holding a public round table Tuesday
to explore several issues around securities lending, which has expanded
into a big moneymaker for Wall Street firms and pension funds.
Regulation hasn't kept pace, some industry participants contend.
Securities lending is central to the practice of short selling, in which
investors borrow shares and sell them in a bet that the price will
decline. Short sellers later hope to buy back the shares at a lower
price and return them to the securities lender, booking a profit.
Lending and borrowing also help market makers keep stock trading
functioning smoothly.

--SNIP--

Later on this week I have a story coming out in
Rolling Stone that looks at the history of the Bear Stearns and Lehman
Brothers collapses. The story ends up being more about naked
short-selling and the role it played in those incidents than I had
originally planned -- when I first started looking at the story months
ago, I had some other issues in mind, but it turns out that there's no
way to talk about Bear and Lehman without going into the weeds of naked
short-selling, and to do that takes up a lot of magazine inches. So
among other things, this issue takes up a lot of space in the upcoming
story.

Naked short-selling is a kind of counterfeiting
scheme in which short-sellers sell shares of stock they either don't
have or won't deliver to the buyer. The piece gets into all of this, so
I won't repeat the full description in this space now. But as this week
goes on I'm going to be putting up on this site information I had to
leave out of the magazine article, as well as some more timely material
that I'm only just getting now.

Included in that last category is some of the
fallout from this week's SEC "round table" on the naked short-selling
issue.

The real significance of the naked
short-selling issue isn't so much the actual volume of the behavior,
i.e. the concrete effect it has on the market and on individual
companies -- and that has been significant, don't get me wrong -- but
the fact that the practice is absurdly widespread and takes place right
under the noses of the regulators, and really nothing is ever done about
it.

It's the conspicuousness of the crime that is
the issue here, and the degree to which the SEC and the other financial
regulators have proven themselves completely incapable of addressing the
issue seriously, constantly giving in to the demands of the major banks
to pare back (or shelf altogether) planned regulatory actions. There
probably isn't a better example of "regulatory capture," i.e. the
phenomenon of regulators being captives of the industry they ostensibly
regulate, than this issue.

Taibbi continues on to inform us that none of the
invited speakers to this government-sponsored event represented stockholders
or companies that could, or have, become targets/victims of naked
short-selling. Also "...no activists of any kind in favor of tougher rules
against the practice. Instead, all of the invitees are (were) either banks,
financial firms, or companies that sell stuff to the first two groups."

Taibbi then informs us that there is only one
panelist invited that's in favor of what may be, perhaps, the most basic
level of regulatory control with regard to this industry practice: a "simple
reform" called "pre-borrowing." Pre-borrowing requires short-sellers to
actually possess the stock shares before they're sold.

It's been proven to work, as last summer the SEC,
concerned about predatory naked short-selling of big companies in the
wake of the Bear Stearns wipeout, instituted a temporary pre-borrow
requirement for the shares of 19 fat cat companies (no other companies
were worth protecting, apparently). Naked shorting of those firms
dropped off almost completely during that time.

The lack of pre-borrow voices invited to this
panel is analogous to the Max Baucus health care round table last
spring, when no single-payer advocates were invited. So who will get to
speak? Two guys from Goldman Sachs, plus reps from Citigroup, Citadel (a
hedge fund that has done the occasional short sale, to put it gently),
Credit Suisse, NYSE Euronext, and so on.

Taibbi then tells us of increased efforts by
industry players, specifically noting Goldman Sachs being at the forefront
of this effort, and having "their presence felt."

Taibbi mentioned that he'd received two completely
separate calls from two congressional staffers from different offices--folks
whom Taibbi never met before--who felt compelled to inform him of Goldman's
actions.

We learn that these folks both commented on how
these Goldman folks were lobbying against restrictions on naked
short-selling. One of the aides told Taibbi that they had passed out a "fact
sheet about the issue that was so ridiculous that one of the other staffers
immediately thought to send it to me. "

I would later hear that Senate aides between
themselves had discussed Goldman's lobbying efforts and concluded that
it was one of the most shameless performances they'd ever seen from any
group of lobbyists, and that the "fact sheet" the company had had the
balls to hand to sitting U.S. Senators was, to quote one person familiar
with the situation, "disgraceful" and "hilarious."

Checkout the whole story on his blog. Apparently,
in the upcoming Rolling Stone piece, he gets into the nitty gritty with
regard to how naked short-selling brought down both Bear Stearns and Lehman,
last year.

Should be pretty powerful stuff.

Meanwhile, getting back to the SEC roundtable,
noted above, strike up the fifth item that I've now documented in the past
48 hours where it's becoming self-evident that our elected representatives
and our government agencies aren't even bothering to author the new
regulations and legislation that's so needed to prevent a recurrence of
events such as those we witnessed through the economic/market catastrophes
of the past 24 months; these legislators and high-ranking government
officials are actually having the lobbyists navigate the discussion and
write the damn stuff, too!

How much worse can it get? I really don't want
to know the answer to that rhetorical question. But, with the inmates
running the asylum, we may just find out sooner than we think!

Bailing Out Big Banks Engaged in Sleaze and Sex
"Goldman Laid Down with Dogs," by Ryan Chittum, Columbia Journalism
Review, November 4, 2009 ---
http://www.cjr.org/index.php
This link was forwarded by my friend Larry.

Dean Starkman has been applauding McClatchy’s
series on Goldman Sachs (an Audit funder) for
a couple of
days now. Add another Audit appreciation today.

McClatchy has been doing what Dean has been calling
for for a long time now: Looking much more closely at how Wall Street
fueled the mortgage crisis and how it was deeply connected
to the shadier parts of the
housing industry. Or as McClatchy’s Greg Gordon puts it:

… one of Wall Street’s proudest and most
prestigious firms helped create a market for junk mortgages,
contributing to the economic morass that’s cost millions of Americans
their jobs and their homes.

Today,
McClatchy examines Goldman’s relationshipwith New
Century Financial, a firm that was something of the canary in the coalmine
of this financial crisis—it was the second-biggest subprime mortgage lender
when it went belly-up in April 2007, which was very, very early. In other
words, it was one of the worst actors in the whole mess:

Perhaps no mortgage lender was more emblematic of
the go-go atmosphere in the sprouting industry that was seizing an
outsize share of the home loan market.

Traversing the country in private jets and
zipping around Southern California in Mercedes Benzes, Porsches and even
a Lamborghini, New Century executives reveled as the firm’s annual
residential mortgage sales rocketed from $357 million in 1996 to nearly
$60 billion a decade later…

What does that have to do with Goldman Sachs and
Wall Street?

For $100 million in mortgages, New Century could
command fees from Wall Street of $4 million to $11 million, ex-employees
told McClatchy. The goal was to close loans fast, bundle them into pools
and sell them to generate money for the next round.

Inside the mortgage company, the former
employees said, pressure was intense to increase the firm’s share of an
exploding market for mortgages that depended almost entirely on Wall
Street’s seemingly unlimited hunger for bigger, faster returns.

Aha! But wait—why did Wall Street want to buy this
trash?

Goldman and other investment banks could put $20
million in the till by taking a 1 percent fee for assembling,
securitizing and selling a $2 billion pool of mostly triple-A rated
bonds backed by subprime loans — and that was just stage one.

That takes you to “The
Giant Pool of Money.” And that was far from the
only juice being squeezed from these lemons. Goldman et al got servicing
fees and the like, plus they “extended lines of credit to New Century —
known as “warehouse loans” — totaling billions of dollars to finance the
issuance of more home loans to other marginal borrowers. Goldman Sachs’
mortgage subsidiary gave the firm a $450 million credit line.”

In other words, Wall Street lent the money to the
predatory firms to create the shady loans so it could buy them from them,
slice them into securities and sell them to the greater fools. This was so
profitable there weren’t enough decent loans to be made. So to feed the
beast, mortgage lenders came up with disastrous inventions like NINJA loans
(No Income, No Jobs, No Assets) and Wall Street, ahem, looked the other way.

It was a vicious circle of profit (virtuous—if you
were one of those who lined their pockets through it) and was interrupted
only when the underlying loans got so bad that borrowers like the ones with
no income, no jobs, and no assets in many instances couldn’t even make a
single payment on the loan. Panic!

McClatchy does well to report on the New Century
culture, helpful in illustrating the lie-down-with-dogs-get-up-with-fleas
thing, writing about the sexualization of some of the work, something
reminds us of BusinessWeek’s
fascinating story on the subprime
industry’s descent into decadence (the sub headline on that one should be
all that’s needed to entice you to read that one: “The sexual favors,
whistleblower intimidation, and routine fraud behind the fiasco that has
triggered the global financial crisis.”)

But it wasn’t just sex. New Century was giving
kickbacks to mortgage brokers to get their loans, McClatchy quotes a former
top underwriter there as saying.

Let’s not forget, and McClatchy doesn’t,
thankfully, that borrowers were the marks here and took it on the chin:

The loans laid out financial terms that protected
investors but punished homebuyers. They offered above-market interest
rates, typically starting at 8 percent, with provisions that Lee said
were “rigged” to guarantee the maximum 3 percent rise in interest rates
after two years and almost assuredly another 3 percent increase through
ensuing, twice-yearly adjustments.

On Friday,
the Federal Reserve, SEC and CFTC announced an agreement to begin anointing
"central counterparties" for the credit default swap market. Before the pols
create still more institutions that are too big to fail, and further
endanger taxpayers, they might want to spend time defining the problem they
intend to solve.

The same goes for House Oversight Chairman Henry
Waxman. On Thursday he held his latest hearing designed to blame everything
other than failed housing policy for the credit debacle. Eager to avoid
being scapegoated, hedge-fund managers at the hearing agreed that the credit
default swap market is a problem in need of a regulatory solution. But no
matter how many financiers can be made to swear under the hot lights that
credit default swaps are the problem, reality is not cooperating with this
politically convenient theory. This derivatives market continues to perform
better than the market from which it is derived.

Mr. Waxman's committee exists to stage show trials;
he doesn't have jurisdiction to legislate about credit markets or anything
else. But his media events are helpful to his comrade in exculpation, Barney
Frank. The House Financial Services Chairman is among the most desperate to
blame something other than housing, where he famously vowed to "roll the
dice" with Fannie Mae. He too has fingered credit default swaps and now
promises "sensible" regulation. If he does to this market what he did to
housing, he will again be rolling the dice with other people's money.

Credit default swaps are contracts that insure
against a borrower defaulting on its bonds. The buyer of a CDS contract
essentially pays annual premiums and the seller agrees to pay back the
principal if the issuer of the bonds doesn't. It's different from insurance
in that an investor doesn't actually have to own the underlying bonds -- he
can simply buy a CDS as a way to make a bearish bet on a company or to
offset other risks.

Shattering Beltway illusions, the unregulated CDS
market is holding up better than the regulated bond market. Here we are more
than a year into the credit meltdown and the CDS market is offering more
liquidity than the actual cash market. Eraj Shirvani at Credit Suisse notes
that "over the last 18 months, the CDS market -- not the bond market -- has
been the only functioning market that has consistently allowed market
participants to hedge or express a credit view."

Large investors have often struggled mightily this
autumn to find buyers for their bonds, but they could still trade CDS. The
U.K. government seems to agree this is a good thing. Her Majesty's Treasury
has recognized the CDS market as an efficient mechanism for setting prices
by using it as the benchmark to set the rates in its Credit Guarantee Scheme
for banks.

In the U.S., meanwhile, the market has spoken, and
CDS contracts are the way that investors now price credit. This means
Congress should tread very carefully unless it wants to prolong the
downturn. In an environment in which fewer companies are able to issue bonds
and trading is light, a liquid CDS market that can put a price on credit
will hasten the day when more companies are able to borrow money to build
their businesses. A Congressional overreaction or too heavy a hand from the
New York Fed could delay needed capital from reaching Main Street.

But the Beltway crowd has a vague sense that while
they may not understand this market, financial Armageddon will result when a
major participant fails. Lehman Brothers was supposed to be exhibit A. The
firm was on one end of roughly $5 trillion in CDS contracts, according to
Moody's, and Lehman was itself the subject of $72 billion in CDS, in which
other investors were betting on Lehman's success or failure. Here was the
doomsday scenario, with a major player in CDS going bankrupt.

It turned out to be the meltdown that never melted.
Amazing as it is to Washington ears, those greedy, crazy people running
large financial institutions did a decent job of managing their exposures to
Lehman. When large banks and insurance companies were vulnerable to Lehman,
many had offsetting trades that paid off when Lehman went bust. The net
amount of $6 billion owed by sellers of credit protection on Lehman was far
smaller than expected and was arrived at through the same orderly settlement
auction process that has smoothly managed about a dozen such failures -- and
all without government regulation.

This is not to say that Lehman's failure didn't
damage credit markets. But the problem was not a failure of the CDS market,
nor was Lehman's failure caused by CDS. Toxic mortgages killed Lehman. Once
Lehman went bust, CDS contracts added relatively little stress to other
banks. The stress came from the failure of a big investment bank, which made
people unwilling to lend to other banks.

Identifying major systemic risks in the CDS market
has proven much harder than the pols expected. The big dealers that trade
CDS often demand collateral from customers who owe them money on a trade.
But these big dealers usually don't post collateral when the roles are
reversed and they owe the customer. While this is not necessarily a sweet
deal for small hedge funds doing business with a Goldman or a J.P. Morgan,
it minimizes counterparty risks for the major firms. Also, the large dealers
generally make their money facilitating trades for customers, not betting
one way or another on corporate defaults. So if they sell a lot of credit
protection to one customer, they will seek to buy it from somebody else.

AIG, by contrast, was almost entirely a seller of
CDS. By selling credit protection on mortgage-backed securities, the firm
used CDS to make a big bet on housing, which again is the cause of this
crisis. Meanwhile, the search continues for the major counterparty that
would have been destroyed by AIG's collapse.

As for Mr. Waxman, he should spend more time
investigating the cause, not the effects, of market turmoil. Mr. Frank would
seem to be the perfect witness.

Oh, and don't forget Fannie Mae and Freddie Mac,
those two government-sponsored mortgage giants that engineered the 2008 subprime
mortgage fiasco and are now on the public dole. The Fed kept them afloat by
buying over a trillion dollars of their paper. Now, part of the Treasury's
borrowing from the public covers their continuing large losses. George Melloan, "Hard Knocks From Easy
Money: The Federal Reserve is feeding big government and harming
middle-class savers," The Wall Street Journal, July 6, 2010 ---
http://online.wsj.com/article/SB10001424052748704103904575337282033232118.html?mod=djemEditorialPage_t

Occupy Wall Street is denouncing banks and Wall
Street for "selling toxic mortgages" while "screwing investors and
homeowners." And the federal government recently announced it will be suing
mortgage originators whose low-quality underwriting standards produced
ballooning losses for Fannie Mae and Freddie Mac.

Have they fingered the right culprits?

There is no doubt that reductions in
mortgage-underwriting standards were at the heart of the subprime crisis,
and Fannie and Freddie's losses reflect those declining standards. Yet the
decline in underwriting standards was largely a response to mandates,
beginning in the Clinton administration, that required Fannie Mae and
Freddie Mac to steadily increase their mortgages or mortgage-backed
securities that targeted low-income or minority borrowers and "underserved"
locations.

The turning point was the spring and summer of
2004. Fannie and Freddie had kept their exposures low to loans made with
little or no documentation (no-doc and low-doc loans), owing to their
internal risk-management guidelines that limited such lending. In early
2004, however, senior management realized that the only way to meet the
political mandates was to massively cut underwriting standards.

The risk managers complained, especially at Freddie
Mac, as their emails to senior management show. They refused to endorse the
move to no-docs and battled unsuccessfully against the reduced underwriting
standards from April to September 2004. Here are some highlights:

On April 1, 2004, Freddie Mac risk manager David
Andrukonis wrote to Tracy Mooney, a vice president, that "while you, Don [Bisenius,
a senior vice president] and I will make the case for sound credit, it's not
the theme coming from the top of the company and inevitably people down the
line play follow the leader."

Risk managers had already experimented with lower
lending standards and knew the dangers. In another email that day, Mr.
Bisenius wrote to Michael May (another senior vice president), "we did
no-doc lending before, took inordinate losses and generated significant
fraud cases. I'm not sure what makes us think we're so much smarter this
time around."

On April 5, Mr. Andrukonis wrote to Chief Operating
Officer Paul Peterson, "In 1990 we called this product 'dangerous' and
eliminated it from the marketplace." He also argued that housing prices were
already high and unlikely to rise further: "We are less likely to get the
house price appreciation we've had in the past 10 years to bail this program
out if there's a hole in it."

Donna Cogswell, a colleague of Mr. Andrukonis,
warned that Fannie and Freddie's decisions to debase underwriting standards
would have widespread ramifications for the mortgage market. In a Sept. 7
email to Freddie Mac CEO Dick Syron and others, she specifically described
the ramifications of Freddie Mac's continuing participation in the market as
effectively "mak[ing] a market" in no-doc mortgages.

Ms. Cogswell's Sept. 4 email to Mr. Syron and
others also anticipated the potential human costs of the mortgage crisis.
She tried to sway management by appealing to their decency: "[W]hat better
way to highlight our sense of mission than to walk away from profitable
business because it hurts the borrowers we are trying to serve?"

Politics—not shortsightedness or incompetent risk
managers—drove Freddie Mac to eliminate its previous limits on no-doc
lending. Commenting on what others referred to as the "push to do more
affordable [lending] business," Senior Vice President Robert Tsien wrote to
Dick Syron on July 14, 2004: "Tipping the scale in favor of no cap [on
no-doc lending] at this time was the pragmatic consideration that, under the
current circumstances, a cap would be interpreted by external critics as
additional proof we are not really committed to affordable lending."

Sensing that his warnings were being ignored, Mr.
Andrukonis wrote to Michael May on Sept. 8: "At last week's risk management
meeting I mentioned that I had reached my own conclusion on this product
from a reputation risk perspective. I said that I thought you and or Bob
Tsien had the responsibility to bring the business recommendation to Dick [Syron],
who was going to make the decision. . . . What I want Dick to know is that
he can approve of us doing these loans, but it will be against my
recommendation."

The decision by Fannie and Freddie to embrace
no-doc lending in 2004 opened the floodgates of bad credit. In 2003, for
example, total subprime and Alt-A mortgage originations were $395 billion.
In 2004, they rose to $715 billion. By 2006, they were more than $1
trillion.

In a painstaking forensic analysis of the sources
of increased mortgage risk during the 2000s, "The Failure of Models that
Predict Failure," Uday Rajan of the University of Michigan, Amit Seru of the
University of Chicago and Vikrant Vig of London Business School show that
more than half of the mortgage losses that occurred in excess of the rosy
forecasts of expected loss at the time of mortgage origination reflected the
predictable consequences of low-doc and no-doc lending. In other words, if
the mortgage-underwriting standards at Fannie and Freddie circa 2003 had
remained in place, nothing like the magnitude of the subprime crisis would
have occurred.

Taxpayer losses at Fannie and Freddie alone may
exceed $300 billion. The costs of the financial collapse and recession
brought on by the mortgage bust are immeasurably higher. Unfortunately, the
Obama administration has perpetuated the low underwriting standards that
gave us the crisis and encouraged the postponement of foreclosures by
lending support to various states' efforts to sue originators for robo-signing
violations.

Can you teach an old dog new tricks? In politics,
the answer is usually no. Most elected officials cling to their ideological
biases, despite the real-world facts that disprove their theories time and
again. Most have no common sense, and most never acknowledge that they were
wrong.

But one huge exception to this rule is Democrat
Barney Frank, chairman of the House Financial Services Committee.

For years, Frank was a staunch supporter of Fannie
Mae and Freddie Mac, the giant government housing agencies that played such
an enormous role in the financial meltdown that thrust the economy into the
Great Recession. But in a recent CNBC interview, Frank told me that he was
ready to say goodbye to Fannie and Freddie.

“I hope by next year we’ll have abolished Fannie
and Freddie,” he said. Remarkable. And he went on to say that “it was a
great mistake to push lower-income people into housing they couldn’t afford
and couldn’t really handle once they had it.” He then added, “I had been too
sanguine about Fannie and Freddie.”

When I asked Frank about a long-term phase-out plan
that would shrink Fannie and Freddie portfolios and mortgage-purchase
limits, and merge the agencies into the Federal Housing Administration (FHA)
for a separate low-income program that would get government out of
middle-income housing subsidies, he replied: “Larry, that, I think, is
exactly what we should be doing.”

Frank also said that any federal housing guarantees
should be transparently priced and put on budget. But he added that the
private sector must be encouraged to re-enter housing finance just as the
government gradually withdraws from it.

Some would say Frank’s mea culpa is politically
motivated in advance of an election where bailout nation and big government
are public enemies number one and two. Of course, poll after poll shows that
the $150 billion Fan-Fred bailout, which the Congressional Budget Office
estimates could rise to $400 billion, is detested by voters and taxpayers
everywhere.

In fact, these failed government agencies are in
such bad shape that they can’t even pay Uncle Sam the dividends owed under
the conservatorship deal reached two years ago. That’s right. In order to
pay a $1.8 billion dividend on Treasury department stock, Fan and Fred had
to borrow $1.5 billion from -- you guessed it -- the Treasury.

Then there’s this head-scratching detail: In an
absolutely outrageous move last Christmas Eve, President Obama signed off on
$42 million in bonuses for the top twelve Fannie and Freddie executives,
including $6 million apiece for the two CEOs. (Hat tip to attorney Stephen
B. Meister.)

"It’s hardly news that the near meltdown of
America’s financial system enriched a few at the expense of the rest of us.
Who’s responsible? The recent report of the Financial Crisis Inquiry Commission
blamed all the usual suspects — Wall Street banks, financial regulators, the
mortgage giants Fannie Mae and Freddie Mac,and subprime lenders — which is tantamount to blaming
no one. “Reckless Endangerment” concentrates on particular individuals who
played key roles.

The authors, Gretchen Morgenson, a Pulitzer
Prize-winning business reporter and columnist at The New York Times, and Joshua
Rosner, an expert on housing finance, deftly trace the beginnings of the
collapse to the mid-1990s, when the Clinton administration called for a
partnership between the private sector and Fannie and Freddie to encourage home
buying. The mortgage agencies’ government backing was, in effect, a valuable
subsidy, which was used by Fannie’s C.E.O.,James A. Johnson, to increase home ownership while
enriching himself and other executives. A 1996 study by the Congressional Budget
Office found that Fannie pocketed about a third of the subsidy rather than
passing it on to homeowners. Over his nine years heading Fannie, Johnson
personally took home roughly $100 million. His successor, Franklin D. Raines,
was treated no less lavishly...."

Government-controlled mortgage giant Freddie Mac
has requested $6 billion in additional aid after posting a wider loss in the
third quarter.

Freddie Mac said Thursday that it lost $4.4
billion, or $1.86 per share, in the July-September quarter. That compares
with a loss of $4.1 billion, or $1.25 a share, in the same quarter of 2010.

This quarter's $6 billion request from taxpayers is
the largest since April 2010.

Freddie's losses are increasing mainly for two
reasons: Many homeowners are paying less interest because they are able to
refinance at lower mortgage rates. And failing and bankrupt mortgage
insurers are not paying out as much money when homeowners default.

The government rescued McLean, Va.-based Freddie
Mac and sibling company Fannie Mae in September 2008 after massive losses on
risky mortgages threatened to topple them. Since then, a federal regulator
has controlled their financial decisions.

Taxpayers have spent about $169 billion to rescue
Fannie and Freddie, the most expensive bailout of the 2008 financial crisis.
The government estimates it could cost up to $51 billion more to support the
companies through 2014.

Freddie and Washington-based Fannie own or
guarantee about half of all U.S. mortgages, or nearly 31 million home loans
worth more than $5 trillion. Along with other federal agencies, they backed
nearly 90 percent of new mortgages over the past year.

Charles E. Haldeman Jr., Freddie's chief executive,
said many homeowners are refinancing at lower mortgage rates or are
shortening the terms of their mortgage. While that saves homeowners money,
it is pushing Freddie deeper into the red.

"In fact, borrowers we helped to refinance will
save an average of $2,500 in interest payments during the next year," he
said.

For Freddie, those losses are temporary because
interest rates will remain low for the foreseeable future, said Jim Vogel,
an interest-rate specialist at FTN Financial.

Still, many homeowners are still defaulting on
their mortgages. Unemployment remains stubbornly high at 9.1 percent. The
percentage of those who are late by 90 days or more on their monthly
mortgage payments was virtually unchanged at 3.51 percent in the
July-September quarter.

Another reason Freddie needs more aid is because it
has received less money from mortgage insurers.

Many riskier mortgage loans require insurance,
which is meant to protect lenders and investors from losses if a homeowner
defaults and the lender doesn't recoup costs through foreclosure. The
borrower pays a monthly premium for the insurance, typically a set
percentage of the total mortgage loan. But when those mortgage insurers
fail, they pay out less in claims.

By most accounts, the federally sponsored mortgage
giants Fannie Mae and Freddie Mac did not cause the housing and mortgage
crisis. But they were a big part of the problem, prompting a taxpayer
bailout costing more than $130 billion.

Now, seeking to protect taxpayers from future
meltdowns, the Obama administration wants to phase out the two firms over an
unspecified period and leave the lion's share of the mortgage market to
private lenders. It would be a dramatic change, given that the private
market has shriveled in recent years, leaving Fannie, Freddie and the
Federal Housing Administration to back about 90% of all new home loans. The
administration also proposes a reduced role for the FHA, one that would
focus on providing mortgages for the needy.

How would a phase-out of Fannie and Freddie affect
the availability of mortgages, loan rates and home prices? In the end, would
such a dramatic change be good for homeowners or not?

Opinions vary, and no one can know for sure. The
mortgage and housing markets are complex, and a controlled experiment that
removes Fannie and Freddie but leaves everything else the same is obviously
not possible, says Wharton real estate professor
Todd Sinai. "There's a debate over whether Fannie
and Freddie successfully reduced mortgage rates paid by borrowers, or
increased the mortgage availability for borrowers, or whether they just took
their implicit [government] subsidy and generated higher returns for
shareholders," Sinai says. "If Fannie and Freddie were successful in making
mortgage credit cheaper and more available, then eliminating [them] would
have a negative impact on house prices."

It is not clear that the private market can or
would absorb the volume of business done by Fannie and Freddie, which cover
trillions of dollars worth of loans, according to Wharton real estate
professor
Susan M. Wachter. "That's a good question," she
says, noting that even if the private market were to take over, borrowers
would probably not get the attractive deals they can today.

"The 30-year [mortgage] would become more
expensive," she states, adding that some experts predict a three percentage
point rate rise. With the 30-year, fixed-rate loan now averaging around 5%,
that would take it to 8%, raising the monthly payment for every $100,000
borrowed from $537 to $733. This would make the 30-year fixed loan
"noncompetitive" with adjustable-rate loans, Wachter says. ARMs can offer
lower rates because lenders face less risk, given that they can raise rates
as market conditions change

Jack M. Guttentag, an emeritus professor of
finance at Wharton who runs a website calledThe Mortgage
Professor, thinks fixed rates might go up only
three quarters of a percentage point rather than three points. But with the
two firms' loan guarantees removed from the market, lenders would probably
demand larger down payments than they have in the past, and be less willing
to provide loans to those with less-than-stellar credit. Indeed, today's
tight lending standards, a reaction to the recent crisis, could become
permanent.

"Things like qualification standards have become
extremely strict," Guttentag says, noting that it is now all but impossible
for a self-employed applicant to get a mortgage. "The biggest part of it
would be the increase in the down payment; 20% would probably become the
minimum throughout the marketplace."

Larger down payments reduce the lender's risk
because borrowers are reluctant to default if they have equity in the home,
and because a smaller loan relative to the home's value makes it easier for
the lender to recover in a foreclosure. Currently, most lenders require 20%
down payments; a few years ago, however, it was possible to get a loan with
nothing down. The Obama administration wants underwriting standards to
require at least 10%, though the FHA would continue to offer low-down
payment loans to certain less-affluent borrowers.

Planning a Phase-out

Fannie, the Federal National Mortgage Association,
was formed as a government agency in 1938 and was converted to a publicly
traded company in 1968. Freddie, the Federal Home Loan Mortgage Corp., is a
publicly traded company created by the government in 1970 to provide
competition for Fannie. Their primary role is to buy and insure mortgages
issued by private lenders. Some loans stay on Fannie and Freddie's books,
but most are bundled into mortgage securities sold to investors like other
types of government and corporate bonds. Fannie and Freddie provide
investors certain guarantees that interest and principal payments will be
made even if homeowners default.

Continued in article

Bob Jensen's threads on Fannie and Freddie are at the following links:

A recent move by the Treasury Department to remove
$200 billion caps on assistance to Fannie Mae and Freddie Mac eliminates any
doubt that taxpayers will pay for all their losses for the next three years
and appears to be a major step toward formally nationalizing the housing
enterprises, analysts say.

The government took control of the companies, and
effectively much of the U.S. mortgage market, in September 2008 and started
purchasing all their mortgage-backed securities. But the Treasury previously
used the $200 billion caps on aiding each company to try to limit taxpayer
exposure to their mounting losses.

Republicans charge that Treasury has given the
Depression-era companies a "blank check" to pay for burgeoning losses on
defaulting loans.

The two housing enterprises last year guaranteed
and secured nearly 70 percent of new mortgages, primarily made to "prime"
borrowers with the best credit ratings, while the Federal Housing
Administration insured most loans to subprime borrowers, leaving only a tiny
share of the mortgage market in private hands.

In its Christmas Eve statement announcing the
little-noticed changes, the Treasury insisted that it wants to preserve "an
environment where the private market is able to provide a larger source of
mortgage finance."

But analysts say Treasury's move may push off any
return to a normal mortgage market for years -- possibly forever. Treasury
removed the liability caps for three years and loosened restrictions on
Fannie's and Freddie's purchases of their own mortgage securities --
enabling them to maintain their dominant share of the mortgage market.

"These actions would preserve and strengthen the
governments involvement and control over the countrys housing finance system
and make it harder to reintroduce substantial private-sector involvement
later on," said Edward Pinto, a housing consultant and former chief credit
officer at Fannie Mae.

When combined with a separate move by regulators
not to provide common stock as part of executive compensation at Fannie and
Freddie, the administration's recent actions suggest that it is moving to
nationalize the companies, Mr. Pinto said.

Nationalization, or total government control and
ownership of the companies, would wipe out the value of Fannie and Freddie
stock, making it worthless as a way to pay executives. The value of the
stock has plummeted to between $1 and $2 a share in the wake of the
government's takeover.

Treasury spokesman Andrew Williams declined to
elaborate on the Treasury's actions, but denied that nationalization was the
goal.

The administration is preparing to present its
proposals for governing Fannie and Freddie in the future -- a major question
not addressed in financial reform legislation pending in Congress -- when it
presents its budget in February. Options range from fully nationalizing the
enterprises to reprivatizing them or turning them into public "utilities"
like the closely regulated gas and electric companies.

Sen. Bob Corker, Tennessee Republican, questioned
whether the administration was moving toward nationalization in a letter to
Treasury Secretary Timothy F. Geithner this week, urging the Treasury to
incorporate fully in its February budget the cost of any additional Fannie
and Freddie liabilities the government is acquiring.

"Due to the level of support that this
administration and the previous one have created for Fannie Mae and Freddie
Mac, would you not consider your latest move an effective nationalization?"
asked Mr. Corker, a member of the Senate Banking, Housing and Urban Affairs
Committee. "If so, then the liabilities of these two firms should absolutely
be reflected on the balance sheet of the U.S. Treasury."

Fully nationalizing the enterprises would
permanently increase costs for taxpayers and would bloat the government's
balance sheets. Fannie and Freddie currently guarantee about $5.5 trillion
of outstanding mortgages and debts -- nearly as much as the Treasury's own
public debt. If the companies were fully nationalized, the government's
books would have to reflect both the revenues and losses from those
obligations.

But even if the administration and Congress stop
short of formally incorporating the enterprises into the federal government,
the removal of the caps at least for now has eliminated any doubt that the
government stands behind all Fannie and Freddie obligations and will cover
their losses for the next three years.

Treasury reportedly told Mr. Corker that the move
was needed to calm markets.

Apparently, it deemed the certainty of government
backing to be critical at a time when the Federal Reserve has announced that
it will end its program of purchasing $1.25 trillion in Fannie and Freddie
mortgage bonds in March. The Fed's program -- another unprecedented federal
intervention in the mortgage market -- provided most of the funding to
finance prime mortgages in the past year.

Many housing analysts and economists worry that the
Fed's withdrawal from the mortgage market will cause a sharp rise in 30-year
mortgage rates of as much as one percentage point from 5 percent to 6
percent as private investors demand higher yields to compensate for the
increased likelihood of defaults on mortgages.

Nearly one in eight mortgages is in default, with
prime mortgages guaranteed by Fannie and Freddie having taken over subprime
last year as the principal source of delinquencies.

Rapidly rising delinquencies have prompted some
analysts to predict a collapse in the mortgage market once the Fed stops
buying most of Fannie and Freddie's debt. The Treasury's move appears
designed to reassure investors and prevent that from happening.

"When you have someone as big as the Fed was in
2009 walking away cold turkey, there have to be bumps along the road," said
Ajay Rahadyaksha, managing director at Barclays Capital. But he expects
investors to be enticed back into the mortgage market because they have
"massive amounts of cash" to invest.

While full nationalization of the enterprises would
be controversial, and likely provoke overwhelming Republican opposition,
most parties agree that after the massive efforts to prop up the mortgage
market in the past two years it would be difficult for the government to
entirely extricate itself in the future.

Former Treasury Secretary Henry M. Paulson Jr. said
he intended to keep the government's options open when he designed the plan
to take 79.9 percent control of Fannie and Freddie and put them under
government conservatorship.

But he said they should not be returned to their
previous ambiguous structure, where they were owned by private stockholders
even as they carried out a government mission. He said the best structure in
the future might be to turn them into public utilities that funnel the
government's guarantee on mortgage-backed securities for a fee.

The Mortgage Bankers Association and other private
groups have endorsed a permanent federal role in guaranteeing pools of prime
mortgages, perhaps through a revamped Fannie and Freddie.

One reason heavy government involvement is likely
to continue is that Fannie and Freddie -- unlike many banks that received
bailouts from the Treasury -- likely will never be able to fully repay the
nearly $100 billion in assistance they have received so far from taxpayers,
analysts say.

Their losses are growing by the day, and many of
them now are incurred as a result of new mandates from the Treasury and
Congress to spearhead the government's efforts to alleviate the home
foreclosure crisis and make credit available as widely as possible.

For example, Fannie recently said it may liberalize
its rules for mortgages used to buy condominiums in Florida -- an area that
has been plagued with high rates of default and foreclosure, while it is
giving preference to homeowners over investors when it sells foreclosed
properties, even if investors offer a better deal.

Many analysts expect the administration to soon
increase the subsidies the enterprises are providing to homeowners and banks
that renegotiate mortgages to try to avoid foreclosure, and some suspect it
already is using Fannie and Freddie to make loans available to riskier
borrowers.

Mr. Corker said the proliferation of government
mandates for the enterprises has essentially turned them into "a direct
extension of the Treasury Department."

Happy New Year, readers, but before we get on with
the debates of 2010, there's still some ugly 2009 business to report: To
wit, the Treasury's Christmas Eve taxpayer massacre lifting the $400 billion
cap on potential losses for Fannie Mae and Freddie Mac as well as the limits
on what the failed companies can borrow.

The Treasury is hoping no one notices, and no
wonder. Taxpayers are continuing to buy senior preferred stock in the two
firms to cover their growing losses—a combined $111 billion so far. When
Treasury first bailed them out in September 2008, Congress put a $200
billion limit ($100 billion each) on federal assistance. Last year, the
Treasury raised the potential commitment to $400 billion. Now the limit on
taxpayer exposure is, well, who knows?

The firms have made clear that they may only be
able to pay the preferred dividends they owe taxpayers by borrowing still
more money . . . from taxpayers. Said Fannie Mae in its most recent
quarterly report: "We expect that, for the foreseeable future, the earnings
of the company, if any, will not be sufficient to pay the dividends on the
senior preferred stock. As a result, future dividend payments will be
effectively funded from equity drawn from the Treasury."

The loss cap is being lifted because the government
has directed both companies to pursue money-losing strategies by modifying
mortgages to prevent foreclosures. Most of their losses are still coming
from subprime and Alt-A mortgage bets made during the boom, but Fannie
reported last quarter that loan modifications resulted in $7.7 billion in
losses, up from $2.2 billion the previous quarter.

The government wants taxpayers to think that these
are profit-seeking companies being nursed back to health, like AIG. But at
least AIG is trying to make money. Fan and Fred are now designed to lose
money, transferring wealth from renters and homeowners to overextended
borrowers.

Even better for the political class, much of this
is being done off the government books. The White House budget office still
doesn't fully account for Fannie and Freddie's spending as federal outlays,
though Washington controls the companies. Nor does it include as part of the
national debt the $5 trillion in mortgages—half the market—that the
companies either own or guarantee. The companies have become Washington's
ultimate off-balance-sheet vehicles, the political equivalent of Citigroup's
SIVs, that are being used to subsidize and nationalize mortgage finance.

This subterfuge also explains the Christmas Eve
timing. After December 31, Team Obama would have needed the consent of
Congress to raise the taxpayer exposure beyond $400 billion. By law,
negative net worth at the companies forces them into "receivership," which
means they have to be wound down.

Unlimited bailouts will now allow the Treasury to
keep them in conservatorship, which means they can help to conserve the
Democratic majority in Congress by increasing their role in housing finance.
With the Federal Reserve planning to step back as early as March from buying
$1.25 trillion in mortgage-backed securities, Team Obama is counting on Fan
and Fred to help reflate the housing bubble.

That's why on Christmas Eve Treasury also rolled
back a key requirement of the 2008 bailout—that Fan and Fred begin shrinking
the portfolios of mortgages they own on their own account, which total a
combined $1.5 trillion. Risk-taking will now increase, so that the
government can once again follow Barney Frank's infamous advice that the
companies "roll the dice" on subsidies for affordable housing.

All of which would seem to make the CEOs of Fannie
and Freddie the world's most overpaid bureaucrats. A release from the
Federal Housing Finance Agency that also fell in the Christmas Eve forest
reports that, after presiding over a combined $24 billion in losses last
quarter, Fannie CEO Michael Williams and Freddie boss Ed Haldeman are
getting substantial raises. Each is now eligible for up to $6 million
annually.

Freddie also has one of the world's highest-paid
human resources executives. Paul George's total compensation can run up to
$2.7 million. It must require a rare set of skills to spot executives
capable of losing billions of dollars.

Where is Treasury's pay czar when we actually need
him? You guessed it, Fannie and Freddie are exempt from the rules applied to
the TARP banks. The government gave away the game that these firms are no
longer in the business of making profits when it announced that the CEOs
will be paid entirely in cash, though it is discouraging that practice at
other big banks. Who would want stock in the Department of Housing and Urban
Development?

Meanwhile, these biggest of Beltway losers continue
to be missing from the debate over financial reform. The Treasury still
hasn't offered its long-promised proposals even as it presses reform on
banks that played a far smaller role in the financial mania and panic.
Senate Banking Chairman Chris Dodd (D., Conn.) and ranking Republican
Richard Shelby recently issued a joint statement on their "progress" toward
financial regulatory reform, but their list of goals also doesn't mention
Fannie or Freddie.

Since Mr. Shelby has long argued for reform of
these government-sponsored enterprises, their absence suggests that Mr.
Dodd's longtime effort to protect Fan and Fred is once again succeeding. It
would be worse than a shame if, having warned about the iceberg for years,
Mr. Shelby now joins Mr. Dodd in pretending that these ships aren't sinking.

In today's Washington, we suppose, it only makes
sense that the companies that did the most to cause the meltdown are being
kept alive to lose even more money. The
politicians have used the panic as an excuse to reform everything but
themselves.

On Christmas Eve, when most Americans' minds were
on other things, the Treasury Department announced that it was removing the
$400 billion cap from what the administration believes will be necessary to
keep Fannie Mae and Freddie Mac solvent. This action confirms that the
decade-long congressional failure to more closely regulate these two
government-sponsored enterprises (GSEs) will rank for U.S. taxpayers as one
of the worst policy disasters in our history.

Fannie and Freddie's congressional sponsors—some of
whom are now leading the administration's effort to "reform" the financial
system—have a lot to answer for. Rep. Barney Frank (D., Mass.), chairman of
the House Financial Services Committee, sponsored legislation adopted in
2008 that established a new regulatory structure for the GSEs. But by then
it was far too late. The GSEs had begun buying risky loans in 1993 to meet
the "affordable housing" requirements established under congressional
direction by the Department of Housing and Urban Development (HUD).

Most of the damage was done from 2005 through 2007,
when Fannie and Freddie were binging on risky mortgages. Back then, Mr.
Frank was the bartender, denying that there was any cause for concern, and
claiming that he wanted to "roll the dice" on subsidized housing support.

In 2005, the Senate Banking Committee, then
controlled by Republicans, adopted tough regulatory legislation that would
have established more auditing and oversight of the two agencies. But it was
passed out of committee on a partisan vote, and with no Democratic support
it never came to a vote.

By the end of 2008, Fannie and Freddie held or
guaranteed approximately 10 million subprime and Alt-A mortgages and
mortgage-backed securities (MBS)—risky loans with a total principal balance
of $1.6 tri